Timely Topics in Executive Compensation

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An overview of Say-on-Pay, compensation risk analysis, and proposed modifications to executive compensation proxy disclosure.

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Timely Topics in Executive Compensation

  1. 1. Timely Topics in Executive Equity Compensation Say on Pay, Assessment of Compensation Risk & Modifications to Proxy Disclosure William Parsons Principal – CompWiser Consulting Michael Stevens Partner – Alston & Bird, LLP
  2. 2. Say on Pay What is it? How does it work? What effect might it have on your Equity Compensation Programs?
  3. 3. Say on Pay What is “Say on Pay”? • On July 16th 2009, the Treasury delivered draft "say-on-pay" legislation to Congress that would require all publicly traded companies to give shareholders a non-binding vote on executive compensation packages. • “Say on Pay” also included in the “Corporate and Financial Institution Compensation Fairness Act,” which recently passed the House. • The vote is a “yes or no” vote approving the overall executive compensation as disclosed in the proxy statement. • Would apply both to annual compensation and, in the event of a merger or sale of the company, on “golden parachute” payments. © 2009 CompWiser. All Rights Reserved. 3
  4. 4. Say on Pay What is “Say on Pay”? The disclosures that would be subject to the say-on-pay vote include the following: • Compensation Discussion & Analysis (CD&A) • Summary Compensation Table • Grants of Plan-Based Awards • Pension Benefits and Non-Qualified Deferred Compensation • Summaries of golden parachute and potential payments upon termination © 2009 CompWiser. All Rights Reserved. 4
  5. 5. Say on Pay What does Say on Pay not do? • Say on Pay is a non-binding vote. Therefore, organizations are not required to change or modify executive compensation programs even in the case of a “no” vote. • A “no” vote would not necessarily identify specific issues of concern regarding executive compensation. • Under the Treasury Bill, Say on Pay applies only to the executives whose compensation is required to be publicly disclosed in the annual proxy filing of public companies. © 2009 CompWiser. All Rights Reserved. 5
  6. 6. Say on Pay What does Say on Pay hope to accomplish? • Say on Pay is promoted as a way to rein in uncontrolled executive compensation levels. • Say on Pay proponents believe that such legislation will improve director accountability to shareholders by provided a means for shareholders to express opinions on executive compensation. • Say on Pay is intended to allow boards and shareholder to work together to design compensation that gives executives strong incentives to maximize shareholder value. • All of these issues are currently under contentious debate. © 2009 CompWiser. All Rights Reserved. 6
  7. 7. Say on Pay Is Say on Pay truly landing on U.S. shores? • In 2002, the UK adopted regulations mandating an annual non-binding vote on pay, since this time similar policies have been instituted in Australia, Sweden, Norway, and the Netherlands. • In 2007, AFLAC became the first US company to adopt say-on-pay. • The American Recovery and Reinvestment Act required all financial institutions participating in the Troubled Asset Relief Program (TARP) to include an advisory vote in their proxy statements if filed after February 16th 2009. This covered over 300 companies. • In addition to the TARP participants, over 10 public companies including Aflac, Intel and Verizon Communications held advisory votes on executive pay during the 2009 Proxy season • The release of the Treasury’s draft legislation on July 16th is likely to result in say-on-pay becoming mandatory for the 2010 proxy season. © 2009 CompWiser. All Rights Reserved. 7
  8. 8. Say on Pay Is Say on Pay an effective tool? • Although it is non-binding it does provide a means for shareholders to communicate their level confidence in the executive compensation program and trust in the Board of Directors. • A Harvard Business school study published in March 2009 reported numerous examples of UK companies modifying certain compensation practices as a result of consultation arising from say-on-pay. • A review published by Compensia in June 2009 reported that the introduction of an advisory vote seems to have had the following impact: • it has strengthened the links between pay and performance • It has resulted in a reduction of the size of severance packages. • So far, it has not led to a decrease in overall CEO compensation © 2009 CompWiser. All Rights Reserved. 8
  9. 9. Say on Pay How does Say on Pay impact equity compensation programs? • Equity Compensation is a complicated and complex form of compensation. • Current disclosure requirements for equity compensation may muddy the waters with respect to a shareholder comprehension of value. • The Compensation Discussion & Analysis becomes even more critical with respect to communicating aspects of equity compensation programs. • Communication in plain English is key. • Design of equity compensation in terms of both size of award levels and vesting provisions may be impacted. • The design of equity compensation may need to be simplified in order to ease the communication burden to shareholders. • Formally defined ownership guidelines and holding provisions on equity programs may become more commonplace. © 2009 CompWiser. All Rights Reserved. 9
  10. 10. Assessment of Compensation Risk How may a risk assessment impact the design and implementation of your equity programs?
  11. 11. Assessment of Compensation Risk Focus on “Risky” Compensation FPO Started with the Financial Institutions • Four Major TARP/CPP Requirements • Prohibition of incentives tied to “unnecessary and excessive risk” • “Clawbacks” to recover bonuses and incentive payments based on materially inaccurate performance criteria • Prohibition of “golden parachutes” • $500,000 limit on deductibility of compensation © 2009 CompWiser. All Rights Reserved. 11
  12. 12. Assessment of Compensation Risk Additional Limitations on Executive Compensation shortly followed the original rules: • During the TARP assistance period, TARP recipients are prohibited from paying or accruing any bonus, retention award, or incentive Restricted Stock compensation. 33% • Equity Awards were permitted within the following constraints: Annual Cash • Must consist only of restricted stock and Incentives Base Pay be no greater than 1/3 of Total 0% 67% Compensation. • Minimum two-year vesting, with certain Total Compensation Under the exceptions Additional Limitations • Transferability linked to repayment during TARP Assistance Period. © 2009 CompWiser. All Rights Reserved. 12
  13. 13. Assessment of Compensation Risk In addition to the regulated restructuring of executive pay for TARP/CPP participants, requirements were put in place with regards to the assessment of risk in compensation. • Within 90 days of participation a Senior Risk Officer (SRO) must be identified and tasked with the responsibility of overseeing the risk assessment process in coordination with the Compensation Committee and other departments. • Risk assessments of all employee compensation plans required every six months (not limited to executive arrangements). • Compensation Committee should report findings of risk assessment to the CEO and full Board. • Incentive plans encouraging “unnecessary and excessive risk-taking” should be corrected. • Compensation Committee must certify in the annual Proxy filing that process was completed. • Within 90 days of each fiscal year-end of TARP participation, the CEO and CFO must certify that the Compensation Committee met with the SRO to discuss risk in executive incentive pay arrangements. © 2009 CompWiser. All Rights Reserved. 13
  14. 14. Assessment of Compensation Risk How does the focus on risk in executive compensation among financial institutions participating in TARP impact your organization? • Newly proposed proxy disclosure rules include a requirement that all publicly owned organizations address risk in compensation programs. • Required disclosure should discuss relationship between a company’s overall compensation policies and risk. • The discussion extends beyond the executive officers to include all broad- based compensation policies and overall compensation practices for all employees that could affect risk, to the extent these may have a material effect on the company. © 2009 CompWiser. All Rights Reserved. 14
  15. 15. Assessment of Compensation Risk So how does a risk assessment impact equity compensation programs? • Equity compensation is impacted in a number of ways based upon a consideration of risk. • Does the equity compensation program provide an adequate balance between annual short-term cash incentives and three to five year (or longer) equity-based incentives? • If equity compensation programs entail performance vesting, do the performance metrics take into consideration the impact on long-term viability of the organization? Are there claw-back provisions on these programs? • Are the equity vehicles used in equity compensation programs providing a balance between upside and downside potential to ameliorate risk? • Do equity programs have vesting periods of sufficient length to address long- term performance? • Do equity programs have provisions such as ownership requirements or holding provisions to reduce risky behavior? © 2009 CompWiser. All Rights Reserved. 15
  16. 16. Assessment of Compensation Risk So what changes might we expect to see in equity compensation programs in consideration of a focus on risk? • An increase in the use of restricted stock or restricted stock units. Stock options provide little upside or downside after a plummet in stock price. Restricted stock always would provide both an upside and downside to discourage risky behavior. • Holding provisions placed on equity awards. Holding provisions make become more common as companies seek to prevent the quick purchase and sale of vested stock options. • Longer or overlapping vesting periods or performance periods. Equity awards may require vesting over longer periods of time to encourage a longer-term perspective from grant recipients. Overlapping periods may prevent an attempt to increase short-term performance at the risk of performance in future years. • Ownership Requirements To keep executives (and directors) with skin in the game, formalized ownership requirements will likely become more common. • Careful Evaluation of Performance Metrics on Performance vesting awards Both timelines and award levels tied to performance will be carefully considered in light of risk. Maximum award levels may be reduced to prevent risk-taking. © 2009 CompWiser. All Rights Reserved. 16
  17. 17. Modifications to Proxy Disclosure How do the proposed modifications impact your proxy disclosure and compensation benchmarking for the coming year?
  18. 18. Modifications to Proxy Disclosure On July 10, 2009 the SEC issued proposed amendments to its compensation and corporate governance rules. Key changes are as follows: • Revisions to reporting of options and other equity awards. • A discussion of compensation risk and associated analysis in the CD&A. • A discussion Board leadership structure (separation of Chairman and CEO positions) and the role of the Board in risk management. • Enhanced director and director nominee disclosure. • Reporting of shareholder voting results on Form 8-K. © 2009 CompWiser. All Rights Reserved. 18
  19. 19. Modifications to Proxy Disclosure Proposed changes to the reporting of equity awards • In 2006 a major revision to reporting requirements was implemented. The value of equity awards in the Summary Compensation Table was reported in terms of the annual FAS 123(R) expensed value of equity awarded to the Executive Officer. • The proposed changes would require disclosure of the aggregate grant date fair value of awards in accordance with FAS 123(R). • The changes impact the values reported in the Summary Compensation Table as well as in the Director Compensation Table. • Amounts for prior years may be required to be recalculated to provide a uniform methodology for all years included in the table. • The SEC received comments proposing alternative approaches. There has been particular concern regarding reporting performance-vested awards, for which the grant date value may have little relationship to the amounts actually earned. © 2009 CompWiser. All Rights Reserved. 19
  20. 20. Modifications to Proxy Disclosure How would these changes impact executive compensation disclosure? • New hire grants, promotional grants, and “mega grants” could impact which executives will be identified as named executive officers. • Organizations with equity grants on a multiple-year schedule, as opposed to an annual schedule, could experience notable year-to-year variance in compensation. • Compensation benchmarking and assessment of the competitiveness of pay could be remarkably different than prior years depending upon methodologies used to asses equity values. • Under the current economy of relatively low stock prices, the values reported for equity compensation would likely be notably lower than previous values disclosed. © 2009 CompWiser. All Rights Reserved. 20
  21. 21. Modifications to Proxy Disclosure The figure below shows the impact of changes in the reporting for a single year of equity compensation from the annual expensed value to the full grant date fair value. Data is calculated from the 2009 proxy filing of a bay-area technology company. 200% 155% CEO 150% 128% 96% 100% 70% 42% 51% CFO 50% 10% 0% Former -50% CEO -100% -100% -79% -150% Change in Option Value Change in Stock Value Change in Total Comp Value © 2009 CompWiser. All Rights Reserved. 21
  22. 22. Modifications to Proxy Disclosure The figure below shows the impact of changes in the reporting requirements on the three year average equity values. Data calculated from the 2009 filing of a bay-area technology company. 200% 166% CEO 150% 137% 115% 100% CFO 50% 20% Former 0% CEO -50% -48% -58% -100% Stock Options Restricted Stock/ Restricted Stock Units © 2009 CompWiser. All Rights Reserved. 22
  23. 23. Modifications to Proxy Disclosure • Variance in equity compensation values from prior years may be relatively unpredictable and tied to the unique characteristics of the award terms. • Vesting schedules may vary by individual grant and will notably affect reported values. • The interval on the timing of awards will significantly alter reported values. • Actively vesting historical awards will no longer be incorporated in the equity compensation values reported. • Benchmarking and assessment of competitive pay standing must carefully take into considerations the effect of these reporting changes. © 2009 CompWiser. All Rights Reserved. 23
  24. 24. Modifications to Proxy Disclosure New risk analysis required in CD&A. • Discussion of whether and how compensation practices for employees generally (not just NEOs) may have a material effect on the company from a risk perspective. • Specific emphasis on identifying compensation practices that differ between business units. • Specific emphasis on variances in risk and reward structure (where paid out before risk to company is abated). • Analysis should be meaningful, comparing design philosophy, mix of long- and short-term awards, identification of company-specific risks, and disclosure of risk mitigation strategies (clawbacks, holdbacks, discretionary reductions, stock retention requirements, and such) © 2009 CompWiser. All Rights Reserved. 24
  25. 25. Modifications to Proxy Disclosure New disclosure of compensation consultant independence. • If a consultant or its affiliate provides any role in determining or recommending the amount or form of compensation and provides other services (i.e., benefits consulting or actuarial services), must disclose all services and fees paid. • Disclose whether decision to engage consultant for additional services was made or reviewed by management or the board or compensation committee. • Additional disclosure not required if consultant’s role is limited to working on broad-based non-discriminatory plan available generally to all salaried employees. © 2009 CompWiser. All Rights Reserved. 25
  26. 26. Modifications to Proxy Disclosure New disclosure relating to board governance and director qualifications. • Must indicate whether company combines or separates Chairman and CEO roles and why. • If Chairman and CEO roles are combined, must disclose lead independent director and describe his or her specific roles. • Must described board’s role in risk management process, including the specific roles of any committees. • Must describe specific experience, qualifications or skills that qualify a director to serve as a board and committee member. • Must disclose any other public company directorships at any time during past 5 years. • Time period for disclosure of certain legal proceedings extended to ten years. © 2009 CompWiser. All Rights Reserved. 26
  27. 27. Modifications to Proxy Disclosure New disclosure of voting results. • New item 5.07 of Form 8-K would require the disclosure of the results of shareholders votes within four business days (rather than the next 10-Q or 10-K, as currently required). © 2009 CompWiser. All Rights Reserved. 27
  28. 28. Any Questions? William Parsons Principal – CompWiser Consulting wparsons@compwiser.com (415) 894-5556 Michael Stevens Partner – Alston & Bird, LLP mike.stevens@alston.com (404) 881-7970

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