I’ve been listening to the recordings of the sessions at the 22nd Annual NASPP Conference. And frankly, I’ve been surprised—pleasantly surprised by how much I’ve learned. All of the sessions I’ve listened to have been very enlightening, even the ones where I thought I already knew everything on the topic.
Take the session on pay-ratio disclosure. I wasn’t really sure how interesting this session would be, since the rules haven’t been finalized yet. I mean, really, how much could there possibly be to talk about? But it turns out that the panel had a lot to say and all of it was very interesting. So for today’s blog entry, I feature five things I learned from listening to the panel, “Pay Ratio (& Other Issues): Pointers from In-House.”
1. Run a Test Calculation.
If you haven’t already, you really should perform a test of how you will calculate your CEO pay ratio. It might prove to be harder than you expect. Patty Hoffman-Friedes of Seagate Technology noted that they actually didn’t get very far in their test, but they are now much more prepared for the final calculation. Things you haven’t thought about come to light. Patty noted that Seagate provides shoes to employees in China and they had to think about whether those should be included in compensation.
2. How Will the Ratio Be Used?
The panel spent some time discussing how the ratio will be used by ISS and investors. Although it isn’t clear how ISS will use the disclosure, everyone felt that they will eventually use it. But, as Patty noted, perhaps the bigger question is how the NY Times will use the disclosure.
Stacey Geer of Primerica brought up a concern that hadn’t occurred to me: how employees will react when they realize they are below the median. Valerie Ho from ICF explained that she is planning to educate her HR business partners on the ratio, so that they can be prepared to address employee inquiries. She will also be looking to them for feedback on what employees are saying about the ratio.
3. Your Peers Are the Wildcard.
As moderator Barry Sullivan of Semler Brossy noted, the first year the rules are in effect will be a little bit like the Wild West. Everyone will have to decide on an approach and draft their disclosure without really knowing what their peers will be doing and how their ratio will compare to that of their peers.
Panelists recommend using your outside advisors—attorneys and compensation consultants—for a sanity check, since they will at least have some insight into trends and practices among their clients. Ask for feedback on your methodology and help with drafting the disclosure.
4. Year-Over-Year Comparisons Are Likely to be a Challenge.
Several panelists noted concerns about how much variation will exist in the results from one year to the next. If the median employee shifts from the United States to another country, if the company acquires another company, if there is a significant reduction in force, if a new CEO steps in—all of these events, and lots more, could cause significant year-to-year variability in the ratio, which could be confusing for investors and the media. Before you decide on a methodology, make sure you run comparisons of the results for the past several years, so you can get a feel for how much the number changes from one year to the next. And keep this potential for variability in mind when drafting the disclosure.
5. Thorough, Accurate, Ease of Calculation, Reliable, and Reproducible (and Defensible)
The panel touched on the various approaches companies can take to find the median employee. Primerica has 1800 employees located in the US and Canada; Stacy Geer can download W-2 income to a spreadsheet and calculate the median in about ten minutes. But fellow panelist Charles Grace of EMC—with 60,000 employees in 75 countries and upwards of 30 payroll systems—has a much more involved decision-making process. Include all employees in the calculation or use statistical sampling? What compensation to include? Patty Hoffman-Friedes noted that the range of approaches Seagate is considering could involve using salary, using actual wages earned, including benefits, or including all elements of compensation (even shoes for those employees in China).
Patty explained that Seagate has five touchstones that they are using to evaluate the methodologies: thoroughness, accuracy, ease of calculation, reliability, and reproducibility. Barry Sullivan noted that a sixth is defensibility. I think these are great touchstones for any company to consider as it decides on a methodology.
I have another grab bag of topics for you this week.
2013 Say-on-Pay Results Just in time for the 2014 proxy season, Steven Hall & Partners has published a quick summary of the Say-on-Pay vote results for last year’s proxy season. Here are a few facts of interest.
73 companies failed (out of a total of 3,363 companies that held votes. This seems to be up from 2012. Oddly, even with a Google search, I could not find an apples-to-apples comparison, but it seems like just over 60 companies had failing votes in 2012. It’s possible the increase is partly due to more companies having held Say-on-Pay votes.
In the category of “Not Getting the Message,” 15 of the companies with failing votes had failures in prior years.
At one company, Looksmart, 100% of the votes on their Say-on-Pay proposal were against it (which makes them look not so smart). That’s right, even the board voted against their own Say-on-Pay proposal. Apparently there was a complete board turnover, all the executives were fired, and the new execs didn’t own any stock.
New HSR Act Filing Thresholds New HSR Act filing thresholds have been announced for 2014. Under the new thresholds, executives can own up to $75.9 million of stock before potentially having to make the HSR filings. See this memo from Morrison & Foerster for more information. If you have no idea what the HSR Act is, see the NASPP’s excellent HSR Act Portal.
NASDAQ Amends Rules on Compensation Committee Independence NASDAQ has amended its rules on compensation committee independence to provide that compensatory fees (consulting, advisory, et. al.) paid by the company to board members should be considered when evaluating eligibility to serve on this committee, rather than prohibiting these fees outright. The NYSE has always imposed the more lenient standard and apparently NASDAQ received feedback that their more stringent standard might make them less popular. This alert from Cooley has more information.
ISS has proposed changes to its corporate governance policy for 2014. You have until November 4 to comment on the changes.
What’s Changed?
In terms of stock compensation, or even compensation in general, not much. So the good news is this maybe isn’t something you have to spend a lot of time on this year and I can have a short blog entry today. Of course that’s also the bad news–things aren’t going to get any better next year in terms of the restrictions ISS places on your stock compensation program.
Evaluating Alignment of Pay to Performance
The only proposal that relates directly to compensation that ISS is looking at changing is the Relative Degree of Alignment (RDA) measure, which compares the difference between a company’s TSR ranking and its CEO’s pay ranking among its peers. For example, if the company’s TSR ranks in the 25th percentile among its peers (meaning that the company’s TSR is better than only 25% of its peers) and its CEO’s pay is in the 75th percentile (i.e., the CEO’s pay is more than 75% of his/her peers), ISS might be concerned that there is a pay for performance misalignment. This is just one of several measures ISS uses to assess whether CEO pay aligns with company performance.
Currently ISS calculates RDA on a one-year and three-year basis. They are proposing to eliminate the one-year calculation and instead consider only three-year RDA. If your RDA score has been trending downwards, you are probably pleased as punch about this; if your RDA score has been trending upwards, you are probably a little less thrilled (but what goes up most come down and, under the proposed calculation, if you do have a down year, that year won’t impact your RDA score as much).
On September 18, the SEC proposed highly anticipated rules governing the ratio of CEO to median employee pay that public companies will be required to disclose in their proxy statements. In today’s blog, I provide a summary of the proposed rules.
Background
We’ve known this was coming since the Dodd-Frank Act was signed into law. The Act requires the SEC to adopt rules mandating that public companies disclose the ratio of CEO pay to that of the median pay of all other employees (see my blog entry “Beyond Say-on-Pay,” August 5, 2010). It’s taken a while for the SEC to propose the rules because, well, it’s a complicated topic and the SEC has a lot on its plate these days, including a host of other rulemaking projects under Dodd-Frank and the Jobs Act, not to mention investigating Rule 10b5-1 plans.
You Win Some
The Act requires that the ratio of CEO pay to median employee pay be based on “compensation” as defined for purposes of the Summary Compensation Table. So, in a worst case scenario, you could have had to prepare an SCT for all employees just to figure out the median employee compensation.
And, if you want, you can certainly still do that. But, for most companies, it’s about all they can do to put together the SCT for the 5+ execs for whom disclosure is required. So, instead, the proposed rules allow companies to figure out which employee represents the median based on any consistent, systematic method (e.g., based on W-2 income), then determine only that employee’s compensation as per the SCT. The pay ratio disclosure would then simply be the CEO’s pay as compared to the pay of the one employee that represents the median.
You Lose Some
That was the good news. The bad news is that the SEC has interpreted “all employees” to be literally all employees. That includes part-timers, seasonal, and temporary employees, and both US and non-US employees employed as of the last day of the company’s fiscal year. Pay for employees that were hired during the year can be annualized, but annualization is not permitted for seasonal or temporary employees. Likewise, location-based cost-of-living adjustments or full-time adjustments for part-time employees are not permitted.
More Information
For more information, see the NASPP Alert “SEC Proposes CEO Pay Ratio Disclosure Rules.” The proposed rules were issued just days before the NASPP Conference, so speakers at the Conference were able to address them during their presentations. In particular, Keith Higgins, the Director of Corporation Finance at the SEC, discussed the proposed rules in his keynote during the Proxy Disclosure Conference, and Mike Kesner of Deloitte provided a tutorial on the proposed rules in the session “Pay Disparity Workshop & How to Ensure Your Pay Practices Pass.” You can purchase the video of the Proxy Disclosure Conference or purchase the audio for Mike’s session.
Comments on the proposed rules can be submitted to the SEC until December 2, 2013.
Realizable pay has quickly emerged as a hot topic for this proxy season. In today’s blog, I offer a few thoughts on realizable pay as it relates to stock compensation.
Why Realizable Pay?
Realizable pay has emerged as a method for evaluating whether executive pay aligns with company performance. It’s an alternative to comparing company performance to total pay as disclosed in the Summary Compensation Table. For equity awards, pay is disclosed in the SCT at grant and is based on the grant date fair value. Arguably, the pay disclosed in this table is for future performance, not current performance. Also, the grant date fair value is not necessarily a predictor of how much compensation execs will actually receive under the arrangement.
Realizable pay, however, is based not on grant date fair value but on the current value of the company’s stock. Thus, where equity awards are a significant component of executive pay, realizable pay can make for a more compelling story for shareholders: high levels of realizable pay are likely the result of an elevated stock price, which in turn probably means that the company is performing well. On the other hand, poorly performing companies have lower stock prices, resulting in underwater stock options and low levels of realizable pay.
What Is Realizable Pay?
Realizable pay is not a mandated disclosure, so there is no standard definition for it. Generally, it can be expected to include cash compensation paid during the year, plus the intrinsic value of options and awards held by the executive. But, of course, it’s more complicated than that.
Which awards/options? Awards typically vest and pay out in three to four years, but options can be outstanding for up to ten years. The standard that is emerging seems to be to include only options and awards granted within a specified period (e.g., three years). The idea is that the grants that are generating the company’s current performance are the ones made in recent years; grants made earlier generated performance in an earlier time frame.
Vested and Unvested? Technically, executives can really only realize the value of options and awards that are vested. Most companies, however, seem to include both vested and unvested options and awards in realizable pay.
Performance Awards? Where execs hold performance awards, a decision also need to be made as to whether to include these awards at threshold, target, or maximum. These awards could also be included at the level at which they are currently expected to pay out, but companies may be uncomfortable with this approach as it potentially signals management’s expectations as to future company performance.
When Is Realizable Pay Not Realizable?
When ISS calculates it, of course. ISS includes the current Black-Scholes value of options in realizable pay, rather than just their intrinsic value (see “Proxy Advisor Policies for 2013,” November 27, 2012). The Black-Scholes value is generally always going to be higher than the intrinsic value (think fast: ten points if you can name two situations where the Black-Scholes value would not be significantly higher than intrinsic value), so this has the effect of increasing the pressure to outperform peers.
Since it is a holiday week, I thought I’d do something a little lighter. For today’s blog entry, I provide some quips and highlights from Nell Minow’s keynote at this year’s NASPP Conference.
Nell is a phenomenal speaker, outspoken, honest, engaging, and funny. She has not one, but two successful careers as a movie reviewer (she mentioned that she was interviewing Ben Afleck the day after her keynote presentation) and as a corporate governance critic, and is embarking on a third career as an ebook publisher. She was the fourth person to join ISS and she currently works for The Corporate Library/GMI, where they rate boards of directors on their effectiveness and sell those ratings to D&O insurers, plaintiff lawyers, investors, etc.
Nell on how she ended up as a both a film critic and corporate governance critic:
When I was in high school, one of my teachers said to me: “You think you’re going to make a living as a smart aleck?” I did not realize that was a rhetorical question; I thought it was career counseling…I managed to find not one but two careers where I do nothing but criticize people all the time.
On the qualifications for being a critic of either films or corporate governance:
The #1 requirement for being a movie critic or a corporate governance critic: an infinite tolerance for failure.
On the challenges of rating executive pay:
The challenges of rating executive pay are kind of like the challenges of rating movies, which is that so many of them are so terrible.
On Say-on-Pay:
I never really thought [Say-on-Pay] was going to be very effective but I’m extremely impressed and delighted that in just two years, Say-on-Pay has become significant enough that you could get a no vote at Citigroup…But let’s face it, anything that is precatory is not going to be very meaningful.
On director pay:
I used to say that we pay directors too much for what they do and not enough for what we want them to do. So I am in favor of serious pay for directors because we expect them to spend serious time on this…But again, as with CEO pay, you want that pay to be tied to performance.
If she were queen for the day:
I would say that no pay plans, particularly stock-based pay plans, have any credibility whatsoever unless they are indexed, preferably to the peer group but, if not, then to the market as a whole. I would make one sweeping change in that direction…If you are not outperforming your peer group, you shouldn’t get paid the big bucks.
Movie recommendations for the holiday season:
Ben Afleck directed and stars in “Argo,” which I strongly recommend…and no one should go see Kevin James in “Here Comes the Boom.”
Nell had a lot of interesting things to say on a lot of topics related to corporate governance. It’s not too late for you to hear her presentation; you can download her keynote and the panel she participated in afterwards (as well as any other session offered at the Conference). You can purchase just a single session or save with a multi-session package.
Because this is a holiday week, this will be our last blog until next week. I hope everyone has a great Thanksgiving!
For the past few years, in the months leading up to the NASPP Conference, we have featured guest blog entries from some of our Conference speakers. This week we feature our first guest blog entry for the 20th Annual NASPP Conference, by Michael Melbinger of Winston and Strawn, who will lead the session “Issues and Answers on Clawback Provisions.”
A couple of weeks ago the subject of compensation clawbacks burst onto the front pages and into lead stories at newspapers and TV stations all over the country, as a result of JP Morgan Chase’s difficulties. Our scheduled presentation on “Issues and Answers on Clawback Provisions” at the 20th Annual NASPP Conference in New Orleans suddenly got a whole lot more interesting and we are glad to be starting this blog to track thoughts and developments in the meantime.
Compensation clawback provisions have a long history and were developing nicely as a best practice for compensation committees before Dodd-Frank Act Section 954 made them the law of the land (pending the issuance of final rules by the SEC and revised listing standards by the stock exchanges). Reasonable minds, regulators, and courts are differing about how best to handle the design, taxation, and enforcement of clawback provisions.
Mark Poerio, Amylynn Flood, and I will focus our NASPP presentation on the many difficult legal and practical issues raised by a compensation clawback policy, including:
Documentation and drafting requirements,
Legal enforceability issues under state and foreign law,
Establishing procedures for applying the clawback policy,
The accounting consequences of a clawback to the company,
Problematic real-life scenarios for the board and the employees,
The continued applicability of Sarbanes Oxley Act to clawback provisions,
What forms of incentive compensation should be affected by the clawback,
The availability of D&O insurance and indemnification for clawback targets,
Deciding which employees the compensation clawback policy should cover,
The impact of the Dodd-Frank whistleblower bounties on future restatements and clawbacks,
The tax consequences of a clawback to the employee and the company (Code Sections 1341 and 409A),
Possible unintended consequences from the Dodd-Frank clawback provisions and their implementation,
The use of “holdbacks” and deferrals to implement and enforce a clawback policy (see also, Dodd-Frank Act Section 956),
The types of shareholder and employee litigation that are certain to result from a compensation clawback–or the lack of one, and
Balancing the interests of the employees and the company in designing a clawback policy, including protecting employees against an unjust clawback (complete with examples of unjust potential clawback scenarios).
If, as expected, the SEC has proposed rules under Dodd-Frank Section 954 by the time of the NASPP Conference, we will examine those rules in detail–as well as the open issues that are sure to remain under the rules.
Last Change for Early-Bird Rate on M&A Course The early-bird rate for our online program “Tackling Equity Compensation Issues Related to Mergers & Acquisitions” ends this Friday, June 8. We’ve already extended this rate once; we won’t extend it again. Don’t miss out–the next time your company is involved in a deal, you’ll be glad you took this course.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Don’t miss your local NASPP chapter meetings in the Carolinas, DC/VA/MD, Ohio, Seattle, and Silicon Valley. Barbara Baksa will be at the Silicon Valley chapter meeting–be sure to say hello.
We are now well into the second season of Say-on-Pay voting. In today’s blog, I provide an update of the voting thus far.
Turn-Around of the Year?
It’s probably a little too early in the season to award the title for “Turn-Around of the Year,” but Umpqua Holdings looks like a strong contender. Last year, their Say-on-Pay vote received only 35% support–an emphatic message of disapprobation from their shareholders. Their vote this year was of interest to me because they were one of the companies that modified options and awards granted to their officers to be subject to performance conditions (see my April 2, 2011 blog, “Happy Birthday, Dodd-Frank“). The modification was in response to last year’s Say-on-Pay vote, so I was curious to see if this year’s vote went any better. It did–this year’s vote received 95% support.
The turnaround was not entirely attributable to the grant modifications; Umpqua also did a significant amount of outreach to its shareholders and implemented some other programs (including a policy that at least 50% of all equity awards to executive officers must be performance based), but the modifications surely were a factor. In their discussion of their response to last year’s vote, the grant modifications are the second item that Umpqua mentions.
Citigroup
The most notable failure so far has been Citigroup. The vote has caused such a splash that I feel obliged to mention it, but to be honest, I got nothin’ on it. As far as I can tell, the failure didn’t have anything to do with Citigroup’s stock compensation program, putting it squarely in the category of “things I don’t really care about.” I’ve read speculation that the failure had more to do with dissatisfaction with the banking industry than with Citigroup’s executive compensation programs.
Funny Numbers
This year’s Say-on-Pay vote for Cooper Industries may prove that it doesn’t pay to get cute with your Say-on-Pay vote. Last year, Cooper Industries reported that their Say-on-Pay vote passed with 50.4% support. But, to achieve this, Cooper chose not to count abstentions as “against” votes. This is legally permissible and handy for Cooper because if the abstentions had been counted as “against” votes, their Say-on-Pay proposal would have failed last year.
But, in the end, their decision about how to count abstentions earned them only a short reprieve–this year’s Say-on-Pay vote failed with 70.6% of the votes cast against the proposal.
The Round-Up
According to Mark Borges’ Proxy Disclosure Blog on CompensationStandards.com (my #1 source for the most recent Say-on-Pay vote tabulations), there have been seven Say-on-Pay failures in the 2012 proxy season as of yesterday. As of May 2, 2011, there had been eleven failed Say-on-Pay votes, so companies this year seem to be faring slightly better (unless there are four more failures by tomorrow). Of the seven failures this season, only one failed last year (I believe Mark is counting Cooper Industries as a failure in 2011, despite how they counted their own vote). Three of the failures (Citigroup, FirstMerit, and International Games) had received strong support (over 80%) for their Say-on-Pay votes in 2011.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Register for the 20th Annual NASPP Conference in New Orleans. Don’t wait, the early-bird rate is only available until May 31.
Register for the NASPP’s newly updated online Stock Plan Fundamentals program–it’s not too late to get into the course; the first three webcasts have been archived for you to listen to at your convenience.
Risky Behavior and Stock Options The study, which is summarized in the article “The Making of a Daredevil CEO: Why Stock Options Lead to More Risk Taking,” published by Knowledge@Wharton, looked at companies that had recently experienced an increased risk and evaluated which companies took steps to mitigate that risk based on the percentage of their managers’ compensation that is in stock options and the in-the-moneyness of the options.
The researchers found that firms where managers held more stock options took fewer mitigating actions. They felt that this is because once stock options are underwater, the value of the options can’t get any lower. When you think about it, with full value awards, there’s always upside potential but there’s also always downside potential–until the company is just about out of business, the value of the stock can always drop further. But once an option is underwater, it doesn’t matter how low the stock price drops, the option can’t be worth any less. As a result, managers in the study that held more options were less incented to take actions to keep the stock price steady.
Risk and In-the-Moneyness
Interestingly, and in line with this theory, the study also found that when managers’ had in-the-money options they took more mitigating action than when their options were underwater. If there was some spread in the options, the managers were motivated to preserve that spread and thus took action to keep the stock price from dropping. But where there was no spread, the managers were more incented to take risks (presumably in the hopes that the risks would pay off and the stock price would increase).
This is all very interesting; I’ve often wondered (probably here in this blog even) why the media and investors have a bias for full value awards over stock options–I think this is the first plausible explanation I’ve heard for that bias. But here in the NASPP Blog, we view studies like this with a healthy level of skepticism–it’s odd but I’ve never seen a study that didn’t prove the researchers’ initial hypothesis–so I wouldn’t scrap your option plan in favor of full value awards just yet (if you haven’t already done so).
A Nail in the Coffin for Premium-Price Options
I’ve never been a fan of premium-priced options because the reduction in expense is less than the premium, which, to my mind, makes them an inefficient form of compensation. I prefer discounted options, which provide a benefit that exceeds the additional expense to the company.
If this study can be believed, premium options would also discourage executives from taking steps to mitigate risk (whereas discounted options would presumably have the opposite impact). Maybe regulators and investors need to reconsider their bias against discounted options (although, in the case of the IRS, this bias may have less to do with concerns about risk taking and more to do with tax revenue–see my March 16, 2010 blog, “Discounted Stock Options: Inherently Evil or Smart Strategy“).
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
On October 18, ISS issued a preview of some of the policy changes it is considering for the 2012 proxy season. In today’s blog, I take a look at proposed policy changes relating to how ISS evaluates CEO pay and stock plans submitted for shareholder approval for Section 162(m) purposes.
ISS, CEO Pay, and Company Performance
ISS currently evaluates CEO pay and company performance by comparing the company’s TSR to that of its GICS industry group to identify underperformance, then applying a qualitative analysis of various other factors that relate the CEO’s pay to TSR.
Under the newly proposed policy, ISS will apply a relative measure that compares the company’s TSR to that of its peers, which will be determined based on market capitalization, revenue, and GICS industry group. ISS will compare the company’s TSR ranking within the group to that of its CEO pay ranking. ISS will also consider the multiple of the CEO’s pay to the peer-group median.
In addition to the relative measure, ISS will apply an absolute measure that tracks changes in the company’s TSR against changes in its CEO’s pay.
The results of ISS’s pay-for-performance evaluation can impact recommendations ISS issues for the company’s Say-on-Pay proposal and stock plan proposals (if a significant portion of the CEO’s misaligned pay is in the form of equity), as well as individual director nominations.
ISS and Section 162(m)
In the past, when stock plans have been submitted for shareholder approval solely for the purpose of qualifying for exemption under Section 162(m), ISS has generally recommended that shareholders approve the plans. Under the newly proposed policy, however, ISS states that they will complete a full analysis of future plans submitted to shareholder vote for this purposes.This will include consideration of the total shareholder value transfer, burn rate analysis (if applicable), and specific plan features (such as repricing and change-in-control provisions).
This may particularly be a concern for newly public companies that wish to qualify performance unit awards for exemption under Section 162(m). Under recently proposed rules, the IRS clarified that the Section 162(m) exemption for post-IPO grants of stock options, SARs, and restricted stock made during a transition period does not apply to RSUs. Thus, newly public companies that wish to grant exempt performance unit awards will need to submit their plans for shareholder approval, triggering a full analysis of the plan by ISS.
Comments and More Information
ISS accepted comments on the policy through the end of October. (We posted an NASPP alert on the policy changes shortly after ISS issued the proposal. If you follow the NASPP on Twitter or Facebook, then you knew about our alert in time to submit comments to ISS.)
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.