Lululemon, an athletic apparel company, recently received some attention from the media because one of their shareholders (a pension fund) is suing them over an increase to their bonus program that their compensation committee approved just before the company announced a $60 million recall. Emily Cervino of Fidelity forwarded an article (“C-Suite Addiction to Stock Options No Bonus for Shareholders“) on the development to me because she knows of my penchant for both stylish workout gear and stock compensation. It’s rare that I get to combine the two interests.
Arrrggh!
The author of the article uses the Lululemon story as a jumping off point to lambast stock options, eventually making the statement that “While stock options are a no-lose proposition for those who get them, they are a no-win situation for existing shareholders.” Which is ridiculous.
For one thing, as far as I can tell, the suit against Lululemon has nothing to do with stock options. The investors are suing over an increase to the executives’ bonus program, not stock options (the reporter’s tenuous connection is that sometimes incentive compensation takes the form of stock options). Moreover, stock options most certainly aren’t a “no lose” deal for employees, any more than they are a “no-win” proposition for shareholders.
In fact, grants of stock options, rather than cash bonuses, might have been a more palatable solution for shareholders in this case. Unlike bonus plans, stock option payouts are non-discretionary. Either the stock price appreciates or it doesn’t. The compensation committee can’t decide to just pay out more under the options (setting aside the possibility of repricing). And if the company announces a major recall just after options are granted, presumably the company’s stock price will decline and the options will be worthless. If the options aren’t worthless, the stock price didn’t decline and investors haven’t lost money as a result of the recall.
Even if we allow the possibility of repricing, most public companies can’t do that without shareholder approval. Bonus plans, however, can typically be changed with just compensation committee approval (unless the plan is intended to qualify as performance based compensation under Section 162(m)).
What Do Responsible Stock Options Look Like?
The conclusion of the article asks readers to comment on how stock options can be structured to reward workers and protect investors, which got me thinking about what responsible options look like for executives. Here are some of the components that I think make for an option program that aligns with shareholder interests:
No mega grants. Small options granted frequently; never more than a single year’s worth of shares in one grant.
Appropriately sized options for everyone, execs included. When granting to execs, the size of grants should be determined based on option fair value, consideration of several possible payout scenarios, and consideration of the amount of wealth the executive has already accumulated through the company’s compensation programs. I know this thought makes me a communist, but really, how much money does one person need?
No flipping for executives. Require executives to fund exercises through netting, sell-to-cover, cash, or other payment methods that don’t require a sale and implement a holding period on the shares issued to the executive. I’m fine with allowing the rank-and-file to flip, however.
Reasonable caps on the option gain for everyone, execs and rank-and-file. You should really be doing this for full value awards as well. It’s a smart way to reduce plan expense with minimal to no impact on perceived value.
Appropriate clawback policies on shares/gain for execs.
No single-trigger vesting acceleration on a change-in-control (for everyone, both execs and the rank-and-file).
No repricing of options held by executives. Only shareholder approved, value-for-value repricing for the rank-and-file, preferably in lieu of that year’s annual grants, with renewed/extended vesting, and cancelled shares that aren’t regranted are retired (rather than returned to the plan).
I hear it everyday (okay, just about everyday) – companies ask about what the other companies are doing. What types of equity are being issued? How are they handling overhang? What new performance related trends are emerging? I’ve come to an astounding conclusion (yes, I’m exaggerating) – drum roll please – I don’t think the “need to know” about what everyone else is doing is ever going to go away. For all you companies who find yourself in a “want to know” status, there’s new information coming, in the form of the NASPP/Deloitte 2013 Domestic Stock Plan Design Survey. In today’s blog I’ll tell you what you need to do to get the full survey results, and I guarantee you won’t want to miss out on such valuable information.
Data Doesn’t Lie
Results from industry surveys are one of the most valuable acquisitions you can make for your stock administration toolbox. I would say this no matter where I work – it’s the plain truth. It’s often suggested that, as plan administrators, we insert ourselves into plan design and other key discussions involving the use of equity compensation. Fighting for a seat at the table is one thing, but once you get there you need to establish sound credibility with your peers and higher ups. How do you do that? You do it two ways: first by sharing your personal experience (which is no doubt important) and second, you come with data – data on your plans and industry data. How great would it be to hear a proposed plan design element, and be able to respond by saying “actually, the majority of companies are not implementing that type of feature”, or, alternatively “that’s exactly the trend we’re seeing in the industry – 70% of companies report having that feature.” The same scenario rings true for service providers. More and more, issuers are calling on their third parties for opinions and a general “lay of the land” when it comes to considering key decisions. I Want It, How do I Get It?
NASPP members will be able to access the results of the 2013 Domestic Stock Plan Design Survey in the following ways:
Issuers: You must complete the full survey by April 5, 2013 in order to access the results.
Service Providers: Those providers that are not eligible to complete the survey will be able to access the survey results for free, if they are NASPP members. This only applies to service providers – issuers must complete the survey in order to receive the results.
Not an NASPP member? Non members who complete the survey get a 10% discount off an NASPP membership.
How to Get Started
Don’t delay – you only have until April 5th to complete the survey. To get started, register to complete the survey today. Upon registering, you will receive an email within three business days that contains your login to the survey. Once you receive your login, you can immediately begin to complete the survey.
Now is your chance to participate in this important survey and end up with solid data to aid in your plan design efforts.
This week I have a couple of additional treats from the smorgasbord of topics related to stock compensation. Enjoy!
FAQs on ISS Peer Groups I guess I wasn’t the only one confused by ISS’s new peer group methodology; ISS has issued an FAQ to explain the new process.
There’s still a bunch of stuff about 8-digit, 6-digit, 4-digit, and 2-digit GICS codes that I don’t understand, but the gist that I came away with is that peers are selected first from within the company’s 8-digit code. ISS constrains which companies can be considered peers based on size (by revenue and market capitalization), so if there aren’t any 8-digit peers that fit within those constraints, then ISS moves to the 6-digit peers, and then to the four-digit peers. ISS will not select peers that match only based on the 2-digit code.
I finally googled “GICS Codes” to figure out what all these digits mean. Standard & Poor’s assigns companies to ten 2-digit industry groups (your 2-digit GICS code). Then within that 2-digit code, you are assigned to a more specific 4-digit code, and within that 4-digit code…all the way down to the 8-digit code. So the companies that share your 8-digit code should be those that most closely resemble you in terms of industry classification.
When selecting among those peers that meet your size constraints, ISS will give priority to companies that are in your self-selected peer group or that have been selected you as a peer, as well as companies that have been selected as peers by your peers or that have selected by your peers as their peers. This sort of feels like that game “Six Degrees of Kevin Bacon.” Note that if you’ve changed the companies in your self-selected peer group since last year, ISS has provided a special form that you can use to notify them of the change; you have until Dec 21 to do so.
What does all of this have to do with stock compensation you ask? Well, not much, because these peers have nothing to do with the burn rate tables published by ISS (those are based solely on 4-digit GICS codes). ISS uses these peer groups only for purposes of determining whether compensation paid to your CEO aligns with company performance. But it’s good to be aware of your ISS peer group because it probably differs from the peers you’ve identified for purposes of your performance awards and other LTI programs. Thus, even though your CEO has awards that vest based on performance, ISS could still find that his/her pay doesn’t align with company performance.
Top Ten Myths on Say-on-Pay A group of academics from Stanford and the University of Navarra have written a paper to debunk myths related to Say-on-Pay. Beside being an interesting topic, the paper has the advantages of being short (only 14 pages, including exhibits) and is written in fairly straightforward English (the word “sunspot” doesn’t appear in it anywhere).
My favorite myth is #6: “Plain-vanilla equity awards are not performance-based.”
Both ISS and Glass-Lewis have published updated corporate governance guidelines for the 2013 proxy season. The good news for my readers is that, in both cases, there aren’t a lot of changes in the policies specific to stock compensation; I think that Say-on-Pay is a much hotter issue for the proxy advisors right now than your stock compensation plan. Here is a quick summary of what’s changed with respect to stock compensation.
I don’t think ISS made any changes that directly apply to stock compensation, but there were some changes in their general policies on executive and CEO pay that may have an impact on your stock program:
Peer Groups: ISS assigns each company to a peer group for purposes of identifying pay-for-performance misalignments in CEO pay. The determination of company peer groups has been an ongoing source of much consternation; many companies disagree with the peers ISS assigns. In the past, peers have been determined based on GICS codes, market capitalization, and revenue. The new policy involves a lot of technical mumbo jumbo about 8-digit and 2-digit CICS groups that I don’t understand, but the gist that I came away with is that companies’ self-selected peers will somehow be considered in constructing peer groups. I’m not convinced this will be the panacea companies are looking for, but hopefully it will be an improvement.
Realizable Pay: Where ISS identifies a quantitative misalignment in pay-for-performance, a number of qualitative measures are taken into consideration before ISS finalizes a recommendation with respect to the company’s Say-on-Pay proposal. Under the 2013 policy, for large cap companies, these measures will include a comparison of realizable pay to grant date pay. For stock awards, realizable pay includes the value of awards earned during a specified performance period, plus the value as of the end of the period for unearned awards. Values of options and SARs will be based on the Black-Scholes value computed as of the performance period. If you work for a large-cap company, you should probably get ready to start figuring out this number.
Pledging and Hedging: Significant pledging and any amount of hedging of stock/awards by officers is considered a problematic pay practice that may result in a recommendation against directors. My guess, based on data the NASPP and others have collected, is that most of you don’t allow executives to pledge or hedge company stock. But if this is something your company allows, you may want to get an handle on the amounts of stock executives have pledged and consider reining in hedging altogether.
Say-on-Parachute Payments: When making recommendations on Say-for-Parachute Payment proposals, ISS will now focus on existing CIC arrangements with officers in addition to new or extended arrangements and will place further scrutiny on multiple legacy features that are considered problematic in CIC agreements. If you still have options or awards with single-trigger vesting acceleration upon a CIC (and, based on the NASPP and Deloitte 2010 Stock Plan Design Survey, many of you do), those may be a problem if you ever need to conduct a Say-on-Parachute Payments vote.
Glass Lewis Updates
Glass Lewis, in their tradition of providing as little information as possible, published their 2013 policy without noting what changed. I don’t have a copy of their 2012 policy, so I couldn’t compare the two but I’ve read reports from third-parties that highlight the changes.
As far as I can tell, the only change in their stock plan policy is that Glass Lewis will now be on the lookout for plans with a fungible share reserve where options and SARs count as less than one share (the idea is that full value awards count as one share, so options/SARs count as less than a share). It’s a clever idea for making your share reserve last as long as possible, but, to my knowledge, these plans are very rare (I’ve never seen one even in captivity, much less in the wild), so I suspect this isn’t a concern for most of you.
ISS has issued a draft of proposed updates to its corporate governance policies for the 2013 proxy season.
Speak Your Mind–But Be Quick About It
If you have an opinion on the draft that you’d like to express to ISS, you need to get your comments in by October 31. I know you’re thinking that maybe I could have mentioned this a little sooner, but actually, I couldn’t have. The draft was just released last week, after my blog was published. If you follow the NASPP on Twitter or Facebook, however, you at least knew about the draft by last Thursday, when we posted an NASPP alert on it.
You Probably Don’t Have a Lot to Say Anyway
The quick turnaround time for comments probably isn’t a problem because my guess is you aren’t going to have much to say about the proposed changes. ISS is proposing only three changes on their policies relating to executive compensation and only one of those changes relates directly to stock compensation. Here are the proposed changes:
New methodology for determining peer groups
Qualitative analysis will consider how “realizable pay” compares to grant date pay
Allowing executives to pledge company stock will be considered a problematic pay practice
Peer Groups
ISS’s determination of peer groups is critical to their analysis of whether CEO pay aligns with company performance. ISS puts together a peer group of around 14 to 24 companies (I have no idea why 14 to 24 and not, say, 15 to 25–that’s just what ISS says): if your CEO’s pay outpaces the peer group by more than the company’s performance, ISS perceives a possible pay-for-performance disconnect. As noted in my blog “Giving ISS an Earful” (August 14, 2012), the peer group methodology was already an anticipated target for change in this year’s policy.
Up to two years ago, ISS based peer groups solely on GICS codes. Last year, ISS updated it’s policy to base peer groups on revenue and market capitalization, in addition to GICS codes. This year, ISS is further refining peer identification to take into account the GICS codes of the company’s self-selected peers.
Realizable Pay vs. Grant Date Pay
If you follow Mark Borges’ Proxy Disclosure Blog on CompensationStandards.com, you know that a number of companies have been comparing the grant date pay disclosed in the Summary Compensation Table to “realizable pay.” Grant date pay, is, of course, the fair value of awards at grant. Realizable pay is a calculation of how much the executives could realize from their awards as of a specified point in time (usually the end of the year). As I’m sure my reader’s can imagine, the values are usually very diffferent.
Where ISS perceives a pay-for-performance disconnect, it will perform a more in-depth qualitative analysis of the CEO’s pay. In this year’s policy, ISS is proposing to include “realizable pay compared to grant pay” in that analysis.
ISS doesn’t provide any further information, such as what might be considered a favorable comparison or even how “realizable pay” will be determined. In taking a quick gander at the realizable pay disclosures Mark has highlighted recently in his blog, it seems that there is significant variation in practice as to how companies calculate this figure. Some look at pay realizable only from options and awards granted during the current year, others look at all outstanding options and awards, and others look at options and awards granted within a specified range (e.g., five years). I’m not sure whether ISS will perform its own realizable pay calculation (and whether it would have sufficient information to do so) or just accept the number disclosed by the company (assuming a company chooses to make this voluntary disclosure).
More Information
For more information on ISS’s proposed policy updates, including their discussion of the policy around pledging and proposed changes to their policy for Say-on-Parachute-Payment votes, see the NASPP alert “ISS Draft of 2013 Policy Updates.”
If you have concerns or comments that you’d like to voice to ISS about their policies, now is your chance. ISS’s policy survey, the responses to which will be used to formulate their corporate governance policies, is open through the end of this week (Friday, August 17). Speak now or forever hold your piece (well, not really “forever,” presumably they’ll do another survey next year).
This Year’s ISS Policy Survey
The only questions on the survey I noticed that directly address stock compensation were a couple of questions that ask about single-trigger acceleration of vesting of stock awards in the event of a change-in-control. A few other topics in the survey that could indirectly have an impact on stock compensation include:
ISS’s determination of peer groups
How pay should be measured (always a challenge for stock compensation)
Types of performance metrics (e.g., TSR vs. internal metrics)
A few last topics ISS focuses on in the survey that could have an even more indirect impact on stock compensation include director qualifications, director independence, and pledging (e.g., allowing executives to use company stock as collateral for margin accounts or other loans). There also were a bunch of topics that fall under the heading of “Things I Don’t Care About,” so I didn’t read those questions (e.g., corporate lobbying, proxy access, sustainability performance measures).
A Preview of Policy Changes to Come?
The issues covered in the survey are likely indicative of the areas where ISS is considering revising its corporate governance policies for next year–otherwise why would they be asking about these topics? ISS changed its peer group determinations as part of last year’s overhaul of the pay-for-performance analysis (see my blog entry “ISS Policy Updates for 2012,” November 29, 2011); now it looks like ISS may be considering further changes to peer groups. (But probably only for the pay-for-performance analysis; ISS didn’t change peer groups for burn rate purposes last year so I don’t think they’ll change burn rate peer groups for this year either.)
Next Steps
The ISS survey will close this Friday. ISS will hold round-table discussions of the topics covered in the survey during August and September and expects to release the survey results in September. ISS will then accept comments on the results until October and will release its final policy update in November.
Jenn’s on vacation, so I’m blogging twice this week. Since I get an extra entry, I thought I’d focus on one of my favorite topics: why the stock plan administration team should be using focus groups.
Is Your Stock Plan Out of Focus?
A focus group is a small group of employees that give you feedback on your stock programs. It provides a structured mechanism by which you can learn a lot about how employees perceive the company’s stock programs and the education around those programs. And it costs virtually nothing to implement–other than a little time from you and the group participants. Focus groups are one of cheapest yet most effective strategies you can use to improve your stock programs.
Once you start to think about it, I think you’ll realize that there are many aspects of stock plan administration where a focus group could be very helpful. Here are a few ideas to get you started:
Employee Education: A focus group can give you preliminary feedback on any educational materials you create. Do the materials make sense? Do they raise additional questions that aren’t answered? Do employees respond positively to the message? I think that just about every employee communication you distribute and every presentation you do should be run past your focus group first.
Plan Design: Test out new plan designs with the focus group to find out what works and what doesn’t work–before you’ve made a significant investment.
Put an Ear to the Ground: Your focus group can give you a feel for what employees are saying about the company’s stock plans.
Be Prepared: By testing new programs and educational materials with your focus group, you’ll get a feel for how these strategies will be perceived by employees. You won’t be caught off-guard during the official roll-out and you can be proactive about addressing questions and negative comments.
Turn Naysayers Into Cheerleaders: One effective way to silence your critics is to bring them into the process and make them responsible for helping to improve the program.
Who Should be in the Focus Group?
Probably somewhere around 20 people is about the right for the size of the group, depending on the size and diversity of your overall employee population. You don’t want it to be so large that it is unwieldy but you need it to be large enough that you get a representative sample of employee opinions. Also, remember that not everyone will participate in every opportunity to provide feedback, so you want the group to be a little larger than the number of active participants you hope to have.
Here are few thoughts on who to invite to be a part of the group:
Employees that are particularly outspoken or that have demonstrated a strong interest in and/or understanding of the stock program.
Employees that show leadership and won’t be afraid to speak up. Ask department managers for suggestions.
Make sure a wide range of departments and job levels are represented.
Of course, it goes without saying that you should only invite employees that are eligible to participate in the stock plan. If you have multiple plans with differing eligibility criteria, you may need multiple focus groups (e.g., one focus group for the all-employee ESPP and a different focus group for the RSU program that is only offered to managers and above). It also might make sense to have regional focus groups (e.g., a US group and a separate group for EU employees).
Rotate employees in and out of the group regularly–no one should serve for more than year.
Finally, avoid the temptation to pad the focus group with your friends. For one thing, your friends probably don’t need a special, structured program to help them provide feedback to you; they already know where to find you. But also, your friends may not feel comfortable giving you the open, honest feedback that you need.
A policy is only as solid as its exceptions. You may have a well-defined plan or policy for your company’s current situation that has bare spots that may not stand the test of time–and unusual circumstances. It’s difficult to cover all your bases when you are creating a new policy or plan, but it’s even more difficult when you jump into managing an existing plan under inherited policies.
The problem is that it is rare that a stock plan manager has time to pick through every piece of every plan document and policy and play out every scenario to determine if there are cracks that need to be exposed. This is where experience really counts; whether it is your own personal experience or experience you picked up second hand by listening to the holes other stock plan administrators have encountered. Whenever you are networking, attending a presentation, or perusing a discussion forum and you hear a new predicament, run–don’t walk–back to your desk and check to see if your company could potentially run into the same issue.
Just to give you a taste, here are three problems to think about:
Insider Trading Policy
Generally speaking, insider trading policies restrict the transactions of individuals deemed to be in possession of insider information. They help to protect both the company and the individuals by preventing transactions that would either be or appear to be insider trading. However, there are a couple places where ambiguity could trip you up. For example, if your insider policy doesn’t detail what constitutes a transaction, you could find yourself up against (or in the middle of) a blackout period scrambling to determine the correct course of action. Cash exercises and trading shares to cover tax liability on restricted stock vests are the most common sources of contention. Even if you’ve covered yourself by getting all your insiders into Rule 10b5-1 trading plans, there could still be an issue when someone not normally considered to be an insider is marked for a particular blackout period because she or he is either recently promoted or currently in the middle of a project that provides access to nonpublic information. If that same person has, for example, a restricted stock vest during the company blackout window, you could have a situation on your hands.
Fair Market Value
The fair market value for both grants and transactions can be pretty much any reasonable definition, which means that companies may set fair market value differently. Non-market days can be blind spot when it comes to restricted stock vests. Another tricky situation may arise if your FMV is defined in such a way that it is possible for someone to exercise an underwater option. For example, if your company uses the prior day’s closing price as the FMV for option exercises, an employee could exercise barely-in-the-money options and end up with an exercise price that is higher than the defined FMV.
Terminations
Your company can treat all terminations equally, but most companies do not. Voluntary, involuntary, for cause, death, disability, and retirement are all on the list of potentially unique termination reasons with varying impact to equity compensation. Of course, you want to have each reason clearly defined, but the blind spot could be what happens if the circumstance combines more than one reason. For example, what if an employee leaves the company and subsequently passes away during the post-termination grace period?
Take Charge
For larger issues regarding plan design and policy, there are a number of resources on the NASPP site to provide essential guidance. Our April 2010 webcast, “25 Ways to Improve Stock Plan Documents,” details more than 25 plan design issues that you need to be aware of and we have an entire portal dedicated to plan design with a host of resources under multiple topics.
Finally, don’t overlook your opportunities to learn from others. The NASPP has over 30 local chapters planning regular meetings. Making sure you attend your chapter’s meetings gives you access not only to timely topics and great speakers, it also gives you the networking opportunity to discover which issues are most important to your peers and how they are dealing with them. We also have an active Discussion Forum where you can browse, search, and even subscribe to the topics that matter most to you.
For many stock plan administrators, all the press about Say-on-Pay has been just noise. Companies have been submitting their stock plans for shareholder approval for years, decades even, and stock plan administration often isn’t involved with cash-based executive pay, so what role does stock plan administration have here?
Say-on-Pay=Golden Opportunity?
But, I think that Say-on-Pay is a great opportunity for stock plan administrators to show that they deserve a seat at the table when it comes to designing compensation programs. Stock is likely to be a big part of your executives’ compensation and, likewise, a big part of the CD&A. You can help by making sure the folks drafting the CD&A are aware of which features in your stock plans are likely to draw shareholder criticism–and, therefore, may require additional explanation–and which features are likely to please shareholders–and, therefore, should be highlighted. You might even want recommend changes in your stock compensation programs that would make them more shareholder friendly.
The Critical First Year
I see this first year of Say-on-Pay as critical. Clearly, if shareholders have past grievances against your executive pay programs that they don’t feel have been attended to, this is an opportunity for them to express their ire. But, even more important than the Say-on-Pay vote, is the Say-on-Pay frequency vote–in which shareholders decide whether they want to vote on your executive compensation programs every one, two, or three years.
A well-crafted CD&A that addresses all shareholder concerns is critical this year. You want shareholders to feel absolutely confident about the decisions the company is making about executive compensation, so they don’t feel that they need to vote on the compensation every year (or even every two years).
Write a Memo
Now would be a great time to draft a memo for your manager that highlights the good, the bad, and the ugly in the stock compensation paid to your executives, with appropriate recommendations on how each issue might be addressed (or emphasized, for the good stuff) in the CD&A.
The Bad (and the Ugly)
To get you started, here are few stock-compensation related features that can irritate shareholders. If any of these apply to your stock plans, special discussion in the CD&A may be warranted:
Repricing, especially without shareholder approval
Mega grants
Grants made when your stock was at its low point that are now producing windfalls for executives
Paying dividends on unvested performance awards or units
Tax gross-ups
Performance awards where the performance criteria is too easily achieved or that are paid out even if the goals aren’t achieved
Liberal change-in-control provisions (e.g., CIC provisions that allow awards to be paid out even if the deal doesn’t close)
Of course, it goes without saying that discounted stock options are a problem, but, with the backdating scandal mostly behind us and 409A firmly in place, I doubt many, if any companies, still have any of these. Oddly enough, however, shareholders sometimes show an aversion to even at-the-money options over say, full value awards. So if you are still granting predominately stock options to execs, this may bear some discussion, depending on how enlightened your shareholders are.
The Good
And, here’s the flip side–stock compensation-related features that you want to emphasize to your shareholders:
Performance awards with appropriately challenging targets and where the board retains (negative) discretion over payouts
Hold-through-retirement policies and share retention requirements
Clawback and non-complete (and similar) provisions
Award deferral programs (a risk-mitigation strategy, similar to stock retention requirements)
Double-triggers and other responsible CIC provisions
Anti-hedging policies
And More…
Of course, neither of the above is a complete list–this is a blog that is already too long, not an unabridged compendium of executive compensation. If you missed the 18th Annual NASPP Conference, there were a number of sessions presented on Say-on-Pay and executive compensation that provide further information on shareholder hot buttons–purchase the audio for any and all of the these sessions. And the NASPP’s Plan Design Portal has some great articles that might also help with your memo.
Time is Running Out! All NASPP memberships expire on a calendar-year basis. Renew your membership by Dec 31 and you’ll qualify to receive the audio for one NASPP Conference session for free! Don’t wait any longer–you have less than two weeks left to take advantage of this offer!
This offer is also available to anyone the joins the NASPP before December 31–tell all your friends!
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.
Renew your NASPP membership for 2011 (if you aren’t an NASPP member, join today). Renew or join by Dec 31 to qualify to receive the audio of one NASPP Conference session for free.
The New Long-Term Incentive Paradigm–Conserving Share Usage Through Innovative Incentive Design by Myrna Hellerman, Sibson Consulting
The Dodd-Frank Act “Say-on-Pay” provision…something totally new? Not really. For years shareholders have had a voice in compensation decision making, especially through the power to approve incentive and equity compensation plans. They just haven’t used their power to its full potential. Dodd-Frank provides a clearer platform and framework to exercise this power.
Next year we will celebrate the “coming of age,” 18th anniversary of Section 162(m), the infamous “Million Dollar Cap” for non-performance-based compensation. Like Dodd-Frank, there was an expectation that Section 162(m) would “reel in” executive pay, create a greater alignment between pay and performance, and give the shareholder a “say on pay.” The logic was simple: “You lose deductibility of top executive pay if it exceeds $1 million unless the pay is earned under a shareholder approved performance-based incentive compensation plan.” In 2003 the SEC further strengthened shareholder’s “say on pay” by affirming the new NYSE and Nasdaq rules that expanded the shareholder approval requirement to equity compensation plans and amendments thereto.
So, does the existence of the formal Dodd-Frank Say-on-Pay Vote imply that earlier attempts to give shareholders a say on pay have been complete failures. Headline news over the years would suggest this to be so. However, we think not. Successful outcomes just don’t make the headlines. One of these formerly untold success stories will be presented at the 18th Annual NASPP Conference in September. The presentation, “The New Long-Term Incentive Paradigm–Conserving Share Usage Through Innovative Incentive Design,” provides an exemplar outcome in response to a pre-Dodd-Frank “say-on-pay” vote. The takeaways from this presentation will be valuable as organizations prepare for the more formal Say-on-Pay vote required under Dodd-Frank.
In 2005 stockholders rejected an additional share authorization at the 9,000+ employee Arthur J. Gallagher & Co due to burn-rate and dilution concerns. This “No” vote was unexpected at a company with generally shareholder-friendly, conservative pay practices. In response, the organization began a lengthy transformational journey that resulted in a new long-term incentive paradigm. The paradigm recognizes several key realities:
The voice of the shareholder is very powerful. Shareholders need to be continually educated about the company’s pay practices and deserve a reasoned response to their objections.
A purge of poor pay practices and a “diet” to get value transfer and burn-rates into line are not just part of a short-term solution. They are a way of life.
A culture of “ownership” in the long-term success of the organization can be preserved even when there is a paucity of equity. At Gallagher this was accomplished through the use of a uniquely designed, 162(m) compliant long-term cash incentive approach, which mirrors the risks and rewards of equity (this design will be detailed in the presentation).
Management must get comfortable with the difficult, prioritized decisions that are required to effectively manage long-term incentives.
The board, and especially the compensation committee, need to embrace a more intimate role in executive compensation decision making, especially with respect to long-term incentives. Management and the outside independent advisor must provide the education, transparency of information, and the analytics that allow the directors to be successful in this role.
The NASPP Conference presentation and the accompanying discussion will be lead by Myrna Hellerman (SVP, Sibson Consulting), Jon Minor (Sr. Consultant, Sibson Consulting) and Tom Paleka (VP Global Rewards, Arthur J. Gallagher)., three catalysts to Arthur J. Gallagher’s transformational journey that began because of a “say on pay” vote.