Although the NASPP Conference is over, we have one last installment in our “Meet the Speaker” series, showcasing interviews with speakers at the last year’s Conference.
For today’s interview, we feature Fred Whittlesey of Compensation Venture Group, who led the session “Spotlight on the Board: ‘Gotchas’ in the Design, Governance and Administration of Director Compensation in Today’s Market.” Here is what Fred had to say:
NASPP: Why is a discussion of board compensation particularly timely right now?
Fred: Despite the focus on executive compensation, typically labeled in the media as “CEO pay,” compensation for boards of directors has not attracted a similar level of attention. Interestingly, while board compensation committees determine executive pay, they also determine their own pay. There have been few cases directly challenging board compensation, though we highlighted one in our panel presentation. Compensation professionals should expect growing scrutiny of board compensation.
But understanding director compensation is much more complex due to the combination of retainers, meeting fees, additional compensation for chair roles and committee activity. Just look at the Director Summary Compensation Table and try to understand the vast range of pay within each company.
NASPP: What is one action should companies be taking now?
Fred: I predict that the direction that shareholders and advisers will take on director compensation is the “total cost of board” metric. I’ve been advising boards on this metric for over 20 years and have never seen anyone else address it.
The question is how much should good governance cost? The number of directors, number on each committee, and number of meetings collectively have grown. While meeting fees have generally gone away, the sheer volume of directorships and pay levels is going to come under scrutiny. Every company should be calculating this number and comparing within the peer group they use for executive and board pay.
NASPP: What is the most innovative approach you’ve seen to board compensation?
Fred: I’m finally convincing boards to develop a board compensation philosophy. It’s not required, not regulated, and not subject to disclosure. Raising this issue with boards is eye-opening for them. You set your own pay. How do you determine your own pay? Is it your “independent” compensation consultant whom you hired to set executive pay and also advises you how to set your own pay? Soon shareholders and advisers are going to catch on to this practice.
NASPP: What is your favorite memory from a past NASPP Conference?
Fred: The first NASPP conference. I think everyone there realized we were at the beginning of something innovative and significant. Today, many NASPP members wouldn’t understand that there was a time when there was no NASPP or equivalent. Where did we get our information and knowledge? How did we network with equity compensation peers? How did we keep up with new developments? It’s been an amazing 25 years.
About the NASPP Conference
The 25th Annual NASPP Conference is over but it’s not too late to take advantage of the more than 50 breakout sessions on today’s most timely topics in stock and executive compensation. All the keynotes and full-length breakout sessions have been archived and are available in MP3 format; purchase Fred’s session, “Spotlight on the Board: ‘Gotchas’ in the Design, Governance and Administration of Director Compensation in Today’s Market” and any other sessions you are interested in today.
For today’s blog, I discuss trends in the use of equity in compensation outside directors, as noted by consulting firm Frederic W. Cook & Co. in its 2016 Director Compensation Report.
The study includes 300 public companies of varying sizes in the financial services, industrial, retail, technology, and energy sectors. FW Cook has been publishing this study annually for well over a decade (the earliest report I can find on their website is from 2001). The 2016 study found that on average more than half (57%) of total director compensation is paid in the form of equity awards (in general, the larger the company, the greater the percentage of stock compensation for directors). It’s worth looking at a few of the trends in the use of equity in director compensation.
Trend #1: Restricted Stock/Unit Awards
With respect to the use of restricted stock and units versus stock options, the study found that:
Most of the studied companies (more than 80%) grant only restricted stock/RSUs to directors (no stock options).
Use of full-value-only equity programs increased year-over-year among small-cap companies while staying flat for large- and mid-cap companies. Option-only programs declined in prevalence at large- and small-cap companies versus last year.
At technology companies in the study, which have historically granted stock options more than companies in other sectors, there has been a significant swing toward the granting of only restricted stock/RSUs to directors (up from 78% to 85% of those companies). The leading sector for stock options is now the industrial group, where 18% of the companies grant stock options to directors.
Two Other Trends
A couple of other trends you should think about for your director compensation, if you aren’t doing these things already:
Compensation Limits: About a third of studied companies now include an annual limit on compensation paid to directors under their equity plans (in increase from prior years—by way of comparison, only 23% of respondents to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration survey included such a limit on director awards). Companies have been adding these limits in response to shareholder litigation over excessive director pay. FW Cook found that these limits are also increasingly covering total pay, not just equity awards.
Ownership Guidelines: A majority of studied companies have director stock ownership guidelines. The study notes that these guidelines have been ubiquitous at large-cap for many years and usage at small- and mid-cap companies has increased.
Does your company issue grants to outside directors out of the same plan that you issue grants to executives and other employees? If do you, does the plan expressly limit the number of shares that can be granted to directors over a specified period of time?
If it doesn’t, you aren’t alone. According to the NASPP/Deloitte Consulting 2014 Domestic Stock Plan Administration Survey, 77% of respondents’ plans don’t include a limit on grants to outside directors. But a recent spate of litigation, including a lawsuit that Facebook recently agreed to settle, suggest that maybe companies should rethink this practice.
What Litigation?
The lawsuits cover a range of issues related to stock and executive compensation. Some suits allege excessive compensation and some allege deficiencies over stock plan disclosures or proxy disclosures. In addition to Facebook, companies that have been targeted in these suits include Republic Services, Citrix Systems, Goldman Sachs, Cheniere Energy, and Unilife. One common denominator in all of these suits, however, is that the plaintiffs allege that because the company’s outside directors can receive unlimited awards under the plans, they aren’t disinterested administrators of the plan.
Why Is Disinterested Administration Important to these Lawsuits?
These lawsuits are all “derivative” actions (which are lawsuits brought by a shareholder on behalf of the corporation, usually alleging that management is doing something that is to the detriment of the corporation). In a derivative lawsuit, the plaintiff has to meet a “demand” requirement for the suit to proceed. Demand means that the plaintiff asked the company to investigate the matter and the company either refused to investigate or the shareholder doesn’t agree with the outcome of the investigation. In a lot of cases, these suits never get past the demand stage.
But, there is an exception to the demand requirement in lawsuits over stock compensation plans. Can you guess what it is? Yep, that’s right, the demand requirement is excused if a majority of the directors administering the plan lack independence. Plaintiffs are claiming that directors who can receive unlimited awards under a plan aren’t disinterested.
What Happened with Facebook?
Well, first of all, once a suit gets past the demand stage, it gets expensive. So the first thing is that Facebook had to spend a bunch of money on their own lawyers. That, in and of itself, is reason enough to want to keep any of these suits from getting past the demand stage.
The settlement Facebook agreed to includes the following provisions:
Corporate governance reforms, including (A) an annual review of all compensation (cash and equity) paid to outside directors, (B) engage a compensation consultant to advise the company on this review and on future compensation to be paid to outside directors, and (C) use the results of the review to make recommendations to the board on future compensation to outside directors.
Submit the 2013 grants to outside directors to shareholder vote (these grants were the subject of the lawsuit). Hopefully the shareholders approve them–I’m not sure what happens if they don’t (but I’m pretty sure it would make a good blog entry).
Submit an annual compensation program for directors to shareholders for approval. The program has to include specific amounts for equity grants and has to delineate annual retainer fees. As far as I can tell, this is a one-time requirement, for Facebook’s 2016 meeting; if I understand the settlement correctly, the board is allowed to make changes to the program in the future, commensurate with the results of the annual review required under #1 above.
Pay an award of attorneys’ fees and expenses to plaintiff’s counsel not to exceed $525,000 (this is, of course, in addition to whatever Facebook has paid to its own counsel).
A Simple Fix
The simple fix to avoid all of this is to have a limit on the awards that can be issued to outside directors in your plan. If your company is submitting a stock plan to shareholder vote this year, it is worth considering adding a limit like this to your plan.
Thanks to Mike Melbinger of Winston & Strawn for providing a handy summary of the Facebook settlement, as well as a number of the other lawsuits, in his blog on CompensationStandards.com (see “Follow-Up on Facebook Litigation Settlement,” January 29, 2016).
Earlier this fall, Frederic W. Cook released the findings of their 2015 Director Compensation study in a report titled “2015 Non-Employee Director Compensation Report”. In today’s blog I share some of the stock compensation related highlights from their report.
Demographics
The study was conducted with analysis of non-employee director compensation practices at 300 US public companies across a variety of sectors.
One Size Fits All?
In this year’s study, virtually all size categories (small, medium and large-cap) of companies that were studied compensate non-employee directors with primarily stock compensation (meaning more than 50% of director compensation was paid in stock awards and/or stock options). This continues a trend of increasing the equity compensation piece of the compensation pie, which makes sense when you think about aligning director compensation with the shareholder value they are tasked to oversee. Interestingly, while stock compensation ruled the majority when looking at size of company, it didn’t necessarily represent the majority of compensation in each industry sector. The financial services and industrials sectors have yet to pass the 50% mark in issuing equity over cash (cash still is the majority of compensation in those industries).
Stock Awards Continue Their Reign
The dominant equity compensation vehicle is full value stock awards (or units). 85% of the companies in the study use dollar denominated stock awards rather than share numbers. Stock option grants to directors continue to diminish. The technology sector continues to be the heaviest user of stock options to compensate directors, but even that industry is trending down in stock option usage – only 22% of tech companies issued stock options to directors (down from 32% the prior year).
The Trend Continues: Stock Ownership Guidelines
We’ve previously blogged about the continuing uptick in the number of companies adopting share ownership guidelines for executives and directors. The overwhelming majority (96%) of large-cap companies have stock ownership guidelines in place for directors. Small-cap companies continue to catch up in implementing guidelines for directors, with 60% having some form of guideline and/or retention policy in place. The good news is that’s up from just over half of small-cap companies last year. According to the Frederic W. Cook report, “The median ownership requirement is now five times the annual cash board retainer.” 10% of the companies studied have a mandatory hold-until-retirement policy for directors.
The report on this study, along with many other NASPP and outside surveys and studies can be found in the NASPP’s Survey and Studies portal. NASPP and co-sponsored surveys can also be found in the Surveys section of our website.