stanford closer look series		 1
A Historical Look at Compensation and
Disclosure: Cool and Refreshing!
Compensation and Di...
stanford closer look series		 2
a historical look at compensation and disclosure: cool and refreshing!
stock appreciation ...
stanford closer look series		 3
a historical look at compensation and disclosure: cool and refreshing!
Exhibit 1 — Lorilla...
stanford closer look series		 4
a historical look at compensation and disclosure: cool and refreshing!
Exhibit 2 — Lorilla...
stanford closer look series		 5
a historical look at compensation and disclosure: cool and refreshing!
Exhibit 2 — continu...
stanford closer look series		 6
a historical look at compensation and disclosure: cool and refreshing!
Exhibit 2 — continu...
Upcoming SlideShare
Loading in …5
×

A Historical Look At Compensation and Disclosure: Cool and Refreshing!

372 views

Published on

Compensation and disclosure have grown very complex over time. Is this complexity necessary? Should it be simplified?

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
372
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
5
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

A Historical Look At Compensation and Disclosure: Cool and Refreshing!

  1. 1. stanford closer look series 1 A Historical Look at Compensation and Disclosure: Cool and Refreshing! Compensation and Disclosure The board of directors determines the level and structure of compensation paid to the CEO and other named executive officers (NEO).1 Com- pensation packages should be designed to attract, retain, and motivate executives to perform in ac- cordance with the long-term financial objectives of shareholders. SEC regulations require that companies dis- close compensation, so that shareholders can assess the suitability of pay packages. The guidelines for compensation disclosure are stipulated by Regu- lation S-K, Item 402. Companies are to provide “clear, concise, and understandable disclosure” of all compensation. This includes a summary of total compensation paid, elements of the pay package, the peer group used for comparative purposes in designing compensation, performance metrics used to award variable pay, the fair value of equity-based awards realized and outstanding, stock ownership guidelines, clawback policies, and post-retirement compensation. Companies are also expected to provide “material information that is necessary to an understanding of the registrant’s compensation policies and decisions regarding the named execu- tive officers.”2 Amendments and interpretations by the SEC in recent years have emphasized clarity of disclosure (“plain English”) and ensuring that the relationship between pay and performance is prop- erly explained to shareholders. Compensation and Disclosure at Lorillard Lorillard is best known for producing Newport cigarettes, the top-selling menthol brand in the country. Other famous brands include Old Gold By David F. Larcker and Brian Tayan June 15, 2010 (blended cigarette first introduced in 1926) and Kent (filtered cigarette, 1952).3 The company was originally founded in 1760, making it the oldest tobacco company in the coun- try. In the 1890s, it was absorbed into the trust controlled by the American Tobacco Company, and following the dissolution of the trust in 1911 once again became a freestanding company. In 1968, the company was taken over by the Tisch broth- ers who merged it into their corporate holdings. In 2008, Lorillard separated from its parent Loews Corporation and became an independently traded company. By 2009, it was the third largest tobacco company in the U.S. with an 11 percent market share. As a company with a long-running history, it is interesting to compare Lorillard’s compensation and disclosure from several decades ago to today. Take, for example, 1948. That year, Lorillard had revenues of $140 million and net income of $5.6 million.4 President Herbert Kent earned a salary of $60,000 and had $13,000 paid into his pension account. The company introduced a new incentive compensation program, under which Kent would receive a bonus equal to 1 percent of Lorillard’s net income, executive vice presidents 0.8 percent of net income, and other vice presidents 0.6 percent. The program was simple in design and the specificity of disclosure consistent with what the SEC is encour- aging of companies today (see Exhibit 1). By 2009, both compensation levels and mix had changed. That year, Lorillard had revenues of $5.2 billion and net income of $950 million.5 Chairman and CEO Martin Orlowsky earned total compen- sation of $10.5 million. This comprised $1.2 mil- lion salary, $1.6 million stock awards, $3 million Topics, Issues, and Controversies in Corporate Governance and Leadership S T A N F O R D C L O S E R L O O K S E R I E S
  2. 2. stanford closer look series 2 a historical look at compensation and disclosure: cool and refreshing! stock appreciation rights, $3.9 million in annual incentive awards, and $0.7 million pension and other. The pay packages of other named executive officers ranged from $2.2 million to $3.4 million. Compensation levels were based on individual fac- tors, industry benchmarks, and a combination of financial and nonfinancial performance metrics, in- cluding revenue, net income, market share, market share performance, and change in shipments. Both the program design and disclosure were substantial- ly more complicated than they had been 60 years before (see Exhibit 2). Why This Matters 1. Compensation packages have grown increasing- ly complex over time. Is this complexity neces- sary to attract and motivate qualified executive talent? Is it time for companies to reduce the complexity of their compensation programs? 2. Compensation disclosure has grown more exten- sive in length and detail, and yet the relationship between performance and compensation is per- haps less clear than it was years ago. There seems to be a disclosure problem for companies and an understanding problem for shareholders. Where does the problem lie: with compensation consul- tants (who help create the plans), board mem- bers (who approve them), or lawyers (who draft the disclosure)? Is it time to simplify things?  1 Named executive officer (NEO) is an SEC designation that includes the chief executive officer, the chief financial officer, and the three most highly compensated executive officers. 2 Regulation S-K, Item 402, Available at: http://www.law.uc.edu/ CCL/regS-K/SK402.html. 3 See: L. Gruber, “Lorillard and Tobacco 200th Anniversary.” Jun. 5, 1998. Available: http://tobaccodocuments.org/lor/91708377-8444. html?zoom=750&ocr_position=above_foramatted&start_ page=11. 4 Moody’s Manual of Investments, 1949. 5 Lorillard, form 10-K for the year ending Dec. 31, 2009, filed Feb. 25, 2010 with the SEC. David Larcker is the Morgan Stanley Director of the Center for Leadership Development and Research at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Brian Tayan is a researcher with Stanford’s Cen- ter for Leadership Development and Research. They are coauthors of the books A Real Look at Real World Cor- porate Governance and Corporate Governance Matters. The authors would like to thank Michelle E. Gutman for research assistance in the preparation of these materials. The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in cor- porate governance and leadership. The Closer Look Series is published by the Center for Leadership Development and Research at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stan- ford University. For more information, visit: http://www.gsb.stanford.edu/cldr. Copyright © 2012 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
  3. 3. stanford closer look series 3 a historical look at compensation and disclosure: cool and refreshing! Exhibit 1 — Lorillard: Compensation and Disclosure (1948) Remuneration of All Directors and nominees during fiscal year ending, Dec. 31, 1947 (1) (2) (3) (4) (5) (6) Herbert A. Kent President $ 60,000 $ - $ 29,177 $ 12,780 $ 17,539 George D. Whitefield Exec. VP 45,000 - 24,608 11,657 12,339 Edgar S. Bowling Director 36,000 - 21,337 1,817 1,999 Todd Wool VP, Secretary 36,000 - 21,337 2,984 8,299 William J. Halley VP, Treasurer 36,000 - 21,337 4,759 14,330 Frank Hopewell VP 36,000 4,038 21,337 5,790 12,354 James A. Glascock Manager 20,400 - 14,558 7,250 7,281 Irvin H. Peak Manager 23,000 3,000 15,837 2,536 6,250 1. The name of such person; 2. The aggregate remuneration received by such person from the Company and its subsidiaries, directly or indirectly; 3. The amount of the excess remuneration received for the fiscal year ended Dec. 31, 1947, over the remuneration received for the fiscal year ended Dec. 31, 1946, in all cases where such excess exceeds 10%; 4. The net amount each person would receive after payment of Federal income taxes, assuming that each person had no other income and was a married man with two children; 5. The amount paid into the Employees’ Retirement Plan by the Company for each such person during the fiscal year ended Dec. 31, 1947. In no case did such payment exceed by more than 10% the payments made during the fiscal year ended Dec. 31, 1946; 6. The amount each such person will receive annually upon retirement, assuming the attainment of retirement age and the continuation of the salary rate in effect Dec. 31, 1947. The proposed new By-law, which is being submitted by the management for the vote of the stock- holders, reads as follows: Article XII: Incentive Compensation for Officers and Key Personnel Section 1. As soon as reasonably may be after the end of the calendar year 1948, and of each calendar year of the Company’s existence thereafter, the Treasurer shall submit to the Board of Directors a certificate […] certifying the amount of “incentive compensation income” for such cal- endar year, which “incentive compensation income” shall be an amount equal to the consolidated net income of the Company […] in accordance with generally accepted principles of accounting […] minus the sum of (a) an amount equal to the dividends for such calendar year […] and (b) an amount equal to $1.20 per share on the average number of shares of Common Stock of the Company […] Section 2. The Board of Directors shall cause the following payments and distributions to be made from the “incentive compensation income” as thus certified and approved: • To the President: 1% of such income; • To the Executive Vice President: 8/10 of 1% of such income • To each of the other Vice Presidents: 6/10 of 1% of such income, but not in excess of 2.4% to all Vice Presidents. • To other key personnel: 5.8% of such income, but not in excess of 4/10 of 1% to any one person. […] in each year 10% of incentive compensation income shall be paid to Management under this By-law. Source: Lorillard, Proxy Statement, 1948.
  4. 4. stanford closer look series 4 a historical look at compensation and disclosure: cool and refreshing! Exhibit 2 — Lorillard: Compensation and Disclosure (2010) Summary Compensation Table Salary Stock Awards SARs Non- Equity Incentive Change in Pension All Other Total Martin Orlowsky Chairman, CEO 1,212,308 1,600,058 3,015,528 3,900,000 632,681 109,401 10,469,976 David Taylor CFO 872,219 400,060 753,887 1,248,000 143,825 33,883 3,451,874 Randy Spell EVP Marketing 663,837 300,060 565,416 858,000 380,971 299,321 3,067,605 Ronald Milstein General Counsel 639,298 300,060 565,416 858,000 193,970 129,125 2,685,869 Charles Hennighausen EVP Operations 631,277 260,060 490,027 702,000 130,268 22,444 2,236,076 Base Salary.  We pay base salaries in order to attract and retain leadership talent and to provide a competitive basis of compensation that recognizes the executive’s skills and experience relative to his or her responsibilities in the position. During 2009, the Peer Group and Survey Data were used to construct base salary ranges for all salaried employees, including the Named Executive Officers. The minimum and maximum of each range were set at 75% and 125% of the range mid- point, respectively. This standard grade range spread of 50 percentage points provided a market relevant base salary range for similar company positions with salary growth potential. Individual base pay may deviate from the range midpoint due to specific individual factors applicable to each executive, such as seniority, individual performance, experience level, scope of responsibility, or a unique combination of functional responsibilities. Annual Incentive Awards.  Our annual incentive plan (“AIP”) ensures that a significant portion of each Named Executive Officer’s annual compensation is at risk and dependent upon our overall performance and individual performance criteria intended to align the executive’s interests with shareholder interests. […] 2009 Annual Incentive Plan.  […] In establishing the 2009 payout targets for the Named Execu- tive Officers, the Compensation Committee targeted the 75th percentile of market practice for total cash compensation (comprising base salary and annual incentive compensation) for execu- tives in comparable positions at companies in the Peer Group and Survey Data. The Compensation Committee established incentive plan funding equal to 0.75% of our net income for 2009 for each Named Executive Officer,* subject to the negative discretion of the Compensation Commit- tee based on, among other things, the Company’s performance in three categories — Newport’s performance in the menthol segment expressed in terms of market share; total domestic relative market share performance as compared with our primary competitors; and our wholesale unit shipments rate of change compared with our primary competitors. […] In March 2010, the Compensation Committee evaluated the Company’s performance for pur- poses of determining incentive payouts for the 2009 AIP for the Named Executive Officers using the [metrics above …]. The Compensation Committee also considered the Company’s performance on other metrics, including revenue growth and net income as well as the performance of the Named Executive Officers against their individual performance factors. The Company considers * Authors’ note: It is interesting to note that the sharing parameter is roughly equal to what it was 60 years before.
  5. 5. stanford closer look series 5 a historical look at compensation and disclosure: cool and refreshing! Exhibit 2 — continued R. J. Reynolds Tobacco Company (“Reynolds”), a subsidiary of Reynolds American Inc., and Philip Morris USA Inc. (“Philip Morris”), a subsidiary of Altria Group, Inc., as its primary competitors. The Compensation Committee concluded that the Company significantly outperformed its primary competitors in 2009 on the three key incentive metrics for the 2009 AIP as shown in the table be- low. […] Based on these factors, the Compensation Committee determined that the Company had exceeded the performance target set forth in the 2009 AIP by 70% relative to the payout range (representing 80% of the target payout) and that each Named Executive Officer had achieved his or her individual performance factors for 2009 (representing 20% of the target payout). Ac- cordingly, the Compensation Committee awarded 2009 AIP payouts equal to 156% of the payout target for Messrs. Orlowsky, Taylor, Spell, Milstein and Hennighausen. […] Name 2009 AIP Target Payout 2009 AIP Actual Payout Martin Orlowsky $2,500,000 $3,900,000 David Taylor 800,000 1,248,000 Randy Spell 550,000 858,000 Ronald Milstein 550,000 858,000 Charles Hennighausen 450,000 702,000 Long-Term Incentive Awards.  The third principal element of our compensation program for Named Executive Officers is stock awards which recognize performance over a longer term than annual incentive compensation and encourage the Named Executive Officers to continue their employ- ment with the Company. Stock Award Process.  The Compensation Committee approves and grants annual equity awards to eligible executives, including the Named Executive Officers, at its first regular meeting of the year following the release of the Company’s earnings for the prior year. […]   2009 Stock Awards.  […] In March 2009, upon consultation with Committee’s Compensation Consultant, the Compensation Committee determined that the value of the 2009 Stock Award would be allocated 60% in SARs and 40% in service based restricted stock. The SAR awards were granted in four equal quarterly installments with an exercise price equal to the closing price of our Common Stock on each date of grant. The SAR awards will vest in one-quarter increments begin- ning on the first anniversary of the annual award date (March 12, 2009) and each anniversary date for the following three years. The restricted stock award will vest on the third anniversary of the annual award date, subject to the executive officer’s continued employment with the Company. The SAR awards will expire on the tenth anniversary of the annual award date. These awards generally are non-transferable. The value of each SAR award is directly linked to the amount of appreciation in the price of our Common Stock from the date of grant and have no value if the Newport’s Retail Market Share in the Menthol Segment 2009 Domestic Wholesale Market Share Change Domestic Wholesale Unit Shipments Rate of Change for 2009 2009 35.05 share Lorillard: 0.55 share growth Lorillard: 3.9% decline 2008 34.55 share Philip Morris: 1.96 share decline Philip Morris: 12.2% decline Reynolds: 0.05 share decline Reynolds: 8.7% decline
  6. 6. stanford closer look series 6 a historical look at compensation and disclosure: cool and refreshing! Exhibit 2 — continued price of our Common Stock does not rise following the date of grant, which serves to align the executive’s interests with those of our shareholders. The Compensation Committee determined that this structure provided an appropriate balance between providing performance and reten- tion incentives to the Named Executive Officers and other participating employees and aligning their interests with those of our shareholders. In determining the amount of stock to be awarded to the Named Executive Officers, the Com- pensation Committee targeted the 75th percentile of market practice for our Peer Group and Survey Data for annual equity awards taking into consideration internal equity, individual perfor- mance, promotion potential, retention risk and other factors. Based on this evaluation and the advice of the Committee’s Compensation Consultant, the Compensation Committee established the following award values for the Named Executive Officers. […] Name Targeted Value of 2009 Stock Awards Martin Orlowsky $4,000,000 David Taylor 1,000,000 Randy Spell 750,000 Ronald Milstein 750,000 Charles Hennighausen 650,000 […] The following table sets forth the 2009 Stock Awards for the Named Executive Officers award- ed on March 12, 2009 based on the closing price of our Common Stock on the grant date. Name 2009 SARs 2009 Service Based Restricted Stock Martin Orlowsky 271,838 26,641 David Taylor 67,960 6,661 Randy Spell 50,970 4,996 Ronald Milstein 50,970 4,996 Charles Hennighausen 44,174 4,330 Source: Lorillard, form DEF-14A, filed Apr. 5, 2010 with the SEC. Edited for length.

×