Proxy table changes 021513


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Our new article on the timing of executive compensation proxy table disclosure and suggested changes.

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Proxy table changes 021513

  1. 1. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | www.dolmatconnell.comTiming is Everything – Recommendations for Fixing the Timing Disconnect in the Summary Compensation Table February 2013Proxy disclosure rules have undergone sweeping, metamorphic changes over the last decade. Newcomprehensive compensation tables, Dodd-Frank, “Say on Pay,” the CD&A (Compensation Discussion &Analysis section), and evolving shareholder advisory firm assessment methodologies and influence,among other things, have all been enacted over the years to help enhance the transparency of companypay decisions.With all these changes, the equity values disclosed in the Summary Compensation Table (SCT) remainregrettably disconnected from the time period for which the decisions on the vehicles and amountswere made. This timing disconnect can lead to inaccurate conclusions about pay and performance byanalysts, shareholder advisory firms, the media, etc., who rely on the SCT to inform their analysis, sincethe performance against which the SCT pay is compared may reflect different time periods. Theseinaccurate conclusions can then also have significant implications for say-on-pay votes and Board ofDirector elections, along with reactionary changes to executive pay programs by companies, which maynot be warranted, necessary or in the company’s best interest.Pay-For-Performance Timing DisconnectIssue – The current rules for the SCT can result in inaccurate conclusions about pay for performancealignment since the pay required to be disclosed may reflect multiple performance periods.One of the main tools companies use for making decisions about executive pay levels and pay plandesign changes is the pay-for-performance analysis for the CEO, whereby company pay (both target andactual) and financial performance are compared to a selected group of peer companies (the “PeerGroup”)1. Peer Group proxy and financial data is usually extracted directly through required SEC filings,or through a database service that can aggregate the data with appropriate oversight and qualityassurance protocol. Because of the current proxy disclosure rules, the data displayed in the SCT willoverlap multiple years and decision making cycles, which can lead to inaccurate conclusions about thepay for performance relationship.1 For information on how to select appropriate and defensible Peer Groups, please visit the Resource Section ofour website at 1|P a g e
  2. 2. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | www.dolmatconnell.comThe SCT requires that companies report the following: Non-Equity Stock Option All Other Year Base Salary Bonus Incentive Plan Total Awards Awards Compensation Compensation 2012 $507,423 -- $900,000 $900,000 $450,000 $10,000 $2,767,423Based on the table above, the company is showing all pay received, earned or awarded in 2012.However, some of the decisions that led to that disclosed pay were based on 2011 and 2012performance. For example, 1) Base Salary – One reason base salary is not displayed as rounded a number as one might expect, is that the amount reflects the actual base salary received in 2012, which includes a pro-rated portion of pay at an old salary rate (prior to any increase) and the new rate. For calendar fiscal year companies, pay adjustments are often effective March or April 1 (although some companies have rate increases retroactive to Jan 1), so the disclosed rate often reflects 2-3 months of the old rate and 9-10 months of the new rate. Decisions on base salary are often based on prior year performance and reflect additional responsibilities as companies grow, so for this pay element, the pay-for-performance relationship and disclosure are aligned, although as you’ll see below, our recommendation is to also show the new annualized rate. 2) Non-Equity Incentive Compensation – This pay element is most often the annual bonus from a formal plan that an executive received based on individual or company performance, or both. In our example, the amount would be paid in 2013, for 2012 performance and disclosed in the 2012 year. This relationship is exactly what we want to see for this pay element. We want to know, based on 2012 performance, how much of the target bonus did the executive actually receive. Accordingly, pay, performance and disclosure are all aligned for this pay element. As you’ll also see below, we are also recommending that the target amount be included in the SCT. 3) Equity Awards (Stock and Option Awards) – These columns create the main issue of misalignment under the rules. Unlike the bonus, the equity awards disclosed here will reflect the awards made in 2012 for 2011 performance, not the 2013 awards for 2012 performance. This remains the most glaring disconnect in the entire proxy disclosure, and therefore, pay, performance and disclosure for this pay element are significantly misaligned. 4) Pay-for-Performance Timing Misalignment – As described above, the SCT currently illustrates the pay-for-performance relationship accurately and along the appropriate time frames for only two out of the three critical and most material pay elements. Because equity usually comprises the largest pay element for most executives, the effect of this is timing misalignment becomes 2|P a g e
  3. 3. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | magnified and ultimately can lead to inaccurate conclusions about the pay-for-performance relationship. Since the SCT does not tally the entire actual pay for the year, trying to ascertain it often requires searching for the proverbial needle in a haystack, through pages and pages of text to try to piece it all together. Target pay, when disclosed, also often needs to be pieced together through multiple tables and pages of text as well. Other public sources exist to consult in trying to piece together the most current compensation provided, such as 8-Ks and Form 4s, which generally require companies to report material changes to compensation plans and recent equity grants, respectively, much closer in proximity to when the decisions are made. Those filings, however, are more time consuming and costly to research, and more importantly are usually bare bones and devoid of the underlying rationale that the typical CD&A section typically provides. Consequently, relying on this information may not provide the most accurate or complete depiction of the total actual or target compensation for a particular executive. So, we are generally left with the SCT, and due to the mis-alignment of the pay decision and disclosure timing, it can lead to inaccurate conclusions. Recommendation 1. Change the Rules – If there is an interest in retaining the current rules, as they generally line up with the financial statements for the particular year, our suggestion is to simply mandate the inclusion of another table of current year pay decisions and future target pay. For example: Non-Equity All Other Base Stock Option Year Bonus Incentive Plan Compensation Total Salary Awards Awards Compensation (Estimated)2013 Target $510,000 -- $1,000,000 $1,000,000 $510,000 $10,000 $3,030,0002012 Actual $507, 423 -- $900,000 $900,000 $450,000 $10,000 $2,260,0002012 Target $505,000 -- $1,000,000 $1,000,000 $505,000 $10,000 $3,020,000 Or the table can be broken up into target and actual pay, categorizing the information according to the type of pay: Target Compensation Non-Equity All Other Base Stock Option Year Bonus Incentive Plan Compensation Total Salary Awards Awards Compensation (Estimated)2013 Target $510,000 -- $1,000,000 $1,000,000 $510,000 $10,000 $3,030,0002012 Target $505,000 -- $1,000,000 $1,000,000 $505,000 $10,000 $3,020,000 3|P a g e
  4. 4. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | Actual Compensation Non-Equity All Other Base Stock Option Year Bonus Incentive Plan Compensation Total Salary Awards Awards Compensation (Estimated)2012 Actual $507, 423 -- $900,000 $900,000 $450,000 $10,000 $2,260,000 These tables show the 2012 target opportunity (set based on 2011 factors), the actual amounts paid in 2012 based on performance and other factors for 2012, and future 2013 target opportunity. The underlying rationale for each of these line items can be described in the accompanying CD&A. Based on the figures displayed, without further explanation, a reader would be able to ascertain rather quickly that the company or the executive must have underperformed in 2012 since equity awards and bonus payouts are below target and no changes were made to future target pay opportunity. Base salary changed only slightly, likely to reflect changes to the organization scope (e.g., higher revenue base) and market trend, and therefore, by extension, the executive’s responsibility. 2. Provide Supplementary Tables – Many companies are already voluntarily providing supplementary tables like the one above or variations thereof to help more accurately tell their story. Unfortunately, the current rules do not (yet) mandate a standardized format, making consistent comparisons across companies challenging, and in some cases, flawed given the disconnect in timing of the performance and the pay decision. We generally recommend that in addition to complying with the disclosure rules, companies provide supplemental information about decisions for the current year, better aligned with the prior performance in 2012. By doing so, the company can demonstrate the decisions that led to 2012 pay decisions and those that led to 2013 pay decisions. Additional work should be minimal as similar tables have already likely been prepared for the internal discussions and decision making. By providing that additional disclosure, companies will be able to better communicate their story of how pay decisions were made, including what role performance played in the decisions. Rationale Increases Response Time to Shareholder Feedback This main issue with the current rules is that shareholders may be voting on pay decisions that occurred over twelve months ago, when decisions for the current year usually have already been made. If the goal is for shareholders to have a “say” on pay, why have them wait almost two years before any changes would take place. For example, if shareholders vote down the say-on-pay vote in the 2013 proxy for 2012 decisions, the company has likely already made 2013 pay decisions based on 2012 performance, so they would not likely change practices until 2014, nearly two pay cycles after the negative vote. If however, they were casting their vote that also included the recent decisions for 2013, 4|P a g e
  5. 5. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | www.dolmatconnell.comchanges could be implemented in 2013 for 2014 awards and improvements shown in time for the 2014vote.We have seen some commentators suggest companies adjust their grant date timing to later in the yearto accommodate shareholder advisory pay-for-performance assessment models, which rely heavily onthe SCT. Suggesting that companies adjust their performance management cycle, before they wouldhave all the requisite performance information, so that it looks more favorably by a system that isinherently flawed because of the disclosure rules may address the symptom, but does not address thecause.Re-Aligns Disclosure of the Pay Decision with the PerformanceMoreover, by showing the 2012 actual pay and 2013 target pay changes, the shareholders would havethe most current pay information, which they can use to compare against the most current performanceinformation in order to assess the quality of the decision-making. For calendar year companies, theywould have total shareholder return and full year performance information through 12/31 to make peercomparisons. Boards and Companies will also be able to more accurately describe their reasoning formaking the decisions they made both from the prior year (which likely occurred in the beginning part ofthe year) and the current year. The example below highlights this disconnect: Assume the Company awarded a $500K equity award in 2013, $1M equity award in 2012, and $800K award in 2011. For the 2013 proxy, the Company would disclose the $1M award in 2012, which would suggest a 25% year-over-year increase from 2011 to 2012 ($800K to $1M). Let’s also assume that the Company’s total shareholder return for 2012 was -15% and in the bottom quartile of the Peer Group. Due to the disclosure disconnect, this company would look like they increased pay during a year in which the company had significantly underperformed. When in reality, the opposite is true, since they reflected the poor performance in the significantly smaller 2013 equity award, and therefore, had strong pay-for-performance alignment.ConclusionRule changes take time. In the meantime, companies should consider the use of supplemental tables,where appropriate, to ensure that they accurately, completely, and transparently tell their story, so thatthose reading it will have a better chance of understanding how, when, and why pay decisions weremade. Our hope is that companies are not forced to abandon their current approach to their robust andcomprehensive talent and performance management process and make equity grants at the wrongtime, just so that the timing syncs up with external methodologies for measurement based on flawedrules. 5|P a g e
  6. 6. 300 Trade Center, Suite 3460 | Woburn, MA 01801 | 781.392.3600 | www.dolmatconnell.comFor More InformationThis article is intended for informational purposes only and is not meant to be relied upon as specificadvice. For more information about this article, please contact Justin Fossbender at 781-496-3406 or Justin is a Principal consultant out of the firm’s Boston office.About Connell & PartnersAt Connell & Partners, we help clients develop strategic compensation plans that are aligned withshareholder interests and deliver competitive advantage to attract, motivate and retain a high caliberworkforce. We specialize in executive compensation consulting that is dedicated to providingindependent, insightful, and innovative advice in all areas of executive compensation and Board ofDirectors remuneration.Connell & Partners is an independently run division of Gallagher Benefit Services, which is a division ofArthur J. Gallagher (NYSE:AJG), a $2.4B insurance brokerage and risk management services firm. 6|P a g e