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Executive Compensation:
Is it Really Excessive?
James Sillery
Adjunct Professor
John Marshall Law School
1
Overview
 Over the last few decades, there have been clear points in time where
almost everything in executive compensation has changed.
 Today, we are seeing a fundamental redesign of executive
compensation with much more change to come.
 Shareholder activism has increased scrutiny of executive
compensation, resulting in regulatory and legislative changes.
 Companies are rethinking how they pay for performance and what
performance they should pay for.
 The global recession and resultant stock market volatility has changed
the companies and executives think about equity compensation
 Companies are now being challenged to do more than just react to
these changes!
2
Executive pay
 Who are executives?
 Why is executive pay different?
 What makes up an executive pay package
 Why is everyone talking about it?
 What are the current drivers and trends?
 Is it really excessive?
3
Who are executives?
 An “officer” as defined in Rule 16a-1(f) under the Securities
Exchange Act of 1934, and includes the president, the principal
financial officer, the principal accounting officer, any vice
president in charge of a principal business unit, division, or
function (such as sales, administration, or finance), any other
officer who performs a policymaking function, or any other
person who performs similar policymaking functions for that
company.
OR
 More simply, those few key employees responsible for the
professional management of the company.
4
Why is executive pay different?
 High impact.
 High visibility (inside and outside the company).
 Pay for performance: high upside/high risk/high scrutiny.
 Impacted by tax, accounting, legislative and securities
exchange considerations
 Covered by regulations limited to a specific group:
– Section 162(m): $1 million cap on compensation
– Section 280G: Golden parachutes
– IRC Section 4958: Non-Profit Executive Pay
5
What makes up an executive pay package?
 Cash Compensation
– Base salary
– Short-term performance incentive/discretionary bonus
 Deferred compensation/capital accumulation
 Long-Term Incentives (cash and equity)
 Executive perquisites and benefits
 Executive agreements
– Severance
– Change-in-control
6
General practices
 Base salary as a percentage of the total compensation mix has
decreased significantly over the past decade.
 The practice of providing for benefits remains relatively flat.
 There continues to be a greater emphasis on aligning pay and
performance through short and long-term incentives.
 Long-term incentive compensation continues to be a major
component of executive compensation programs in publicly
traded companies.
 To compete, privately held companies are more often
implementing long-term plans that look and act like those in
publicly traded companies.
7
Cash compensation
 Growth in base salaries continue to moderate.
 Research shows that salary increases for executives has
averaged slightly higher than average increases for employees.
 Companies continue to shift compensation from fixed elements,
such as base and benefits to performance–based variable
compensation.
 The most common form of short-term incentive for executives is
a management annual incentive plans
– Participation is limited to top positions, a group pool is funded
based on pre-established criteria and awards are distributed
based upon company, group and/or individual performance.
8
Deferred compensation
 Non-qualified benefits are playing a greater role due to the
declining percentage of compensation deferrable under 401(k)
as income increases.
25.00%
17.50%
11.66%
8.75%
7.00%
5.83%
5.00%
4.37% 3.88%
3.50%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
$70,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 $500,000
Annual Compensation
2013 Maximum Pretax Deferral is $17,500
9
Long-Term Incentives: Stock Options
 Grant of 10,000 options on shares
selling at $10.00 at date of grant.
 Scenario A: stock option
results in a gain of $15.94
per share/$159,400 in total:
– Executive pays a $100,000
exercise price (10,000 x $10). In
return, executive receives stock
worth $259,400 (10,000 x
$25.94)
 Scenario B stock option is
worthless, or underwater:
Executive can purchase stock at
$3.49 on the open market.
$0
$5
$10
$15
$20
$25
0 1 2 3 4 5 6 7 8 9 10
gaingaingaingaingain
$15.94
gain
$3.49
Date of
Grant
Date Fully
Vested
Date of
Exercise
A
B
$25.94
$10
 A stock option is the right to purchase stock at a stipulated price over
a specified period of time.
10
Long-Term Incentives: Restricted Stock
 Grant of 10,000 restricted shares
selling at $10.00 at date of grant.
 Scenario A: Executive receives full
value in shares when they vest;
worth $259,400 (10,000 x $25.94)
 Scenario B Executive receives full
value in shares when they vest;
worth $34,900 (10,000 x $3.49)
$0
$5
$10
$15
$20
$25
0 1 2 3 4 5 6 7 8 9 10
gaingaingaingaingain
$15.94
gain
$3.49
Date of
Grant
Date Fully
Vested
Date of
Exercise
A
B
$25.94
$10
 Executives receive an outright grant of shares at no cost to the
executive, subject to meeting certain requirements.
11
Long-Term Incentives: Performance Share
 The number of shares earned is determined by performance relative
to financial and/or share price performance.
Performance Share Plan
Example: Participant is awarded 20,000 shares, earned out over a three year performance period
Actual
Shares Earned out over 3 Year Period Award
Maximum 150% 30,000
20,000 Target 100% 20,000
Threshold 50% 10,000
If performance is below Threshold, no shares are earned.
Actual award of shares is pro rated, e.g., at 125% performance, 25,000 shares are earned
12
Realistic Assumptions: What the Model Implies Versus What Has
Happened
We have ample evidence that our foundation and models for describing securities returns and
corresponding drivers do not adequately explain what we have seen over the last 25 years…
…But we also don’t have an adequate replacement foundation and set of models
13
Understanding the value of equity compensation is
becoming more complex
Log-Normal Random Stock Prices
Mean = 10% Volatility = 20%
$0
$100
$200
$300
$400
$500
$600
0.0
0.4
0.8
1.3
2.1
2.5
2.9
3.3
3.8
4.2
4.6
5.0
5.4
5.8
6.3
6.7
7.1
7.5
7.9
8.3
8.8
9.2
9.6
10.0
Time (Yrs)
StockPrice
4,2
4,3
4,4
4,1
4,0
5,3
5,2
5,4
5,5
5,1
5,0
1,0
1,1
2,2
2,1
2,0
3,3
3,2
3,1
3,0
0,0
14
Or has the market just changed the rules?
 At lower levels of the organization, restricted stock is more highly
valued while executives valued the upside stock options can offer.
 Restricted shares initially have a higher value, but there is a cross
over point where stock options offer greater opportunity.
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
1 2 3 4 5 6 7 8 9 10
Comparison of Delivered Value of Stock Options to RSUs
Stock Options RSUs
15
Perquisites
 There has been a general decline in the number of perquisites
offered to executives, largely the result of changes in legislation
that eliminated the tax-favored treatment to executives, as well
as increased media focus on “personal” perquisites – the “Jack
Welch Syndrome”.
0% 10% 20% 30% 40% 50% 60% 70%
Company Car or Allowance
Financial Counseling
Legal Counseling
Club Memberships
First Class Air Travel
VIP Lounge Memberships
Spouse Travel Expenses
Special Dining Facilities
Executive Perquisite Practices
CEO Tier 1 Tier 2
16
Executive Agreements
 It is common practice for executives to be covered by
employment agreements.
 These provide the terms of employment, e.g., salary, bonus,
position, perks, etc.
 They also provide protection in the event of termination.
 They are often viewed as necessary to recruit executives.
 Several aspects have become controversial:
– Severance, usually one times base plus bonus for a CEO.
– Change-in-Control, usually 2-3 times base plus bonus and
acceleration of equity grants for a CEO.
– Gross ups keep the executives whole for taxes and/or
penalties.
17
Who sets executive compensation?
 Public Companies vs. Private Companies
– Compensation consultants - provide advice
– CEO - recommend/approve
– Compensation committees – recommend/approve
– Boards of Directors – recommend/approve
– Shareholders/Owners – approve
18
Why is everyone talking about it?
 In the early 1980s,
executive
compensation –
including base
bonus and equity –
began to rise faster
than the earnings of
the average worker.
 CEO compensation
has grown the
fastest, peaking in
2000 at the peak of
the stock market
bubble.
19
Why is everyone talking about it?
“Greed is Good!”
20
Why is everyone talking about it?
21
Topics and Trends in the Headlines
Corporate scandals – executive
compensation visibility
SEC – New disclosure requirements
mandating increased transparency
and quantification
Governance – How should
executive pay be approved… and
who should approve it
FAS 123R – Accounting costs
influencing reward mix
New rounds of regulations and
legislation placing limits on
executive pay
Topics
• Pay limits
• Incentives and risk
• Pay for failure
• Repayment of
bonuses
• Escrowed bonuses &
bonus banks
• Lack of alignment with
shareholders
Trends
• Say on Pay
• Clawbacks
• Option exchanges
• Executive pay cuts
• Gross-up retrenchment
• Performance plans
• Emergence of advisory
firms (ISS/Glass-Lewis)
Caveats
• Focused on Pay for Performance Alignment
• Focused on largest companies
• Actions driven by compliance and concession
• Little focus on innovation
22
Trend #1: Greater Scrutiny
 Public outrage over excessive executive compensation (real
and perceived) has continued without slowing down…
23
Trend #1: Greater Scrutiny
 Prior to the last recession, we saw increased scrutiny of practices
regarding the timing of stock option grants, prompting an investigation
by the SEC into “backdating” practices at 264 companies.
 Backdating allows executives to choose a past date when the market
price was low, thereby inflating the value of the options.
– Backdating is illegal and also unnecessary since the problem could
have been avoided by granting discount stock options.
 Other practices are not illegal, just unethical since it is questionable
whether shareholders knew that this was going on, and if not, whether
they would have approved of it.
– Granting options shortly before announcing good news in this way
is called “spring-loading”.
– Delaying a grant until after bad news is announced is called “bullet-
dodging”.
24
Trend #1: Greater Scrutiny
 Other Hot Buttons:
– Performance: Pay should be supported by performance consistent
with articulated strategy and objectives. Non-performance should
not be rewarded!
– Severance: Severance and termination benefits must be
“reasonable” and consistent with the purpose that the company is
trying to achieve.
– Perquisites: Perquisites have come under increased scrutiny,
especially where they are for “personal” benefit, such as use of
corporate aircraft, spouse travel, etc.
– Supplemental Benefits: Shareholders want full disclosure of
nonqualified deferred compensation plans, particularly when there
is a “preferred or above market” interest being paid.
– Change in Control and Gross Ups: Should the company be
footing the tax bill for excess parachute payments?
25
Trend #1: Greater Scrutiny
 Paying the Piper:
– Former Brocade CEO Gregory Reyes was convicted on conspiracy and
securities fraud charges.
– Adelphi Communications founder John Rigas and his son Timothy
began prison sentences for conspiracy, securities fraud and bank fraud.
– Former Hollinger International Chairman Conrad Black was convicted
of fraud and obstruction of justice.
– Sanjay Kumar, the former head of CA, has begun his prison sentence
for securities fraud and obstruction of justice.
– Former WorldCom founder Bernard Ebbers and former Enron CEO
Jeffrey Skilling are serving prison sentences for securities fraud.
– Former Qwest CEO Joseph Nacchio is serving a prison sentence for
insider trading.
– In one of the largest corporate pay give-backs ever, William W.
McGuire, former CEO of UnitedHealth Group, forfeit $618 million to
settle claims related to back-dated stock options.
26
Trend #2: Greater Disclosure
The SEC disclosure
rules impose:
 A codification of how and what
executive pay data will be disclosed
in the proxy
 A high expectation about how that
data are expected to inform
compensation decisions
Their intent was to provide:
 A clearer and more complete picture
of the compensation earned by a
company’s leadership (executives
and directors)
 Insights into the compensation
decision-making process
27
Trend #2: Greater Disclosure (Round 1)
 Top Five Highest Paid Executives were redefined.
 Objective was to provide wage clarity in “plain English”.
 Report a single compensation dollar figure (“One Number”).
 Dollar value of equity grants in the summary compensation
table.
 Disclosure threshold for perks was reduced to $10,000.
 Specify payments in event of severance/change in control.
 New disclosure table for retirement and NQDC plans.
 New director compensation table.
28
Trend #2: Greater Disclosure (Round 2)
 Creates a new section in the CD&A to discuss and analyze “risks arising from
those compensation policies or practices may have a material effect on the
company.”
 Requires the value of stock and option awards disclosed to be determined
using the aggregate grant date fair value under FAS 123R rather than the
current dollar amount for financial statement reporting.
 Expands the disclosure requirements to include the relevant experience and
qualifications of directors and nominees and other directorships held.
 Requires disclosure of the company’s leadership structure to increase the
transparency for investors as to how boards function.
– Whether the CEO and board chair roles are combined or separate.
– If the roles are separate, whether there is a lead independent director.
– Disclosure of the board’s role in the company’s risk management process,
including credit, liquidity and operational risks.
 Disclosure of Consulting Fees to Compensation Consultants
29
Trend #3: Less Flexibility
 With the passage of the “American Jobs Creation Act of 2004”, IRS
Code Section 409A was created to govern all deferred compensation
arrangements. Earlier this year, the final rules were issued.
 IRC Section 83 vs. IRC Section 409A
– Current cash compensation is treated as ordinary income at the
time that it is received.
– IRC Section 83 governs the transfer of property, including the
equity in a company.
– IRC Section 409A now covers the “gray area” that had existed
between the two.
 To the extent that IRC Section 409A’s strict operational and
documentary requirements are not satisfied, the deferral is considered
“defective” and is generally currently taxable, with interest, and must
pay an additional 20% tax penalty.
30
Trend #3: Less Flexibility
 Section 409A of the Internal Revenue Code of 1986, as amended
(“Code Section 409A”) is broad in scope and has proven to be difficult
for even the most well-intentioned employers to satisfy.
 Any employer which maintains non-qualified deferred compensation
plans for its employees has struggled with Code Section 409A, and
may have concerns that some of its plans might not satisfy the
attention to minutiae that Code Section 409A demands.
 On January 4, 2010, the IRS published its long-awaited program for
correcting documentation failures under Code Section 409A.
 Notice 2010-6 is broken into two component sections.
– First, Notice 2010-6 explains that certain ambiguous plan terms will
not be deemed to violate Code Section 409A.
– Second, Notice 2010-6 lists several specific types of document
failures, and describes applicable correction procedures for each.
31
Trend #4: Dodd-Frank Act
 Major provisions of Dodd-Frank related to compensation
addressed the following areas:
– Say on Pay
– Golden parachute payments
– Independence of Compensation Committees
– Executive Compensation Disclosure
– Clawbacks
– Executive and Director Hedging
32
CEOs are highly compensated…
… But is it really excessive?
33
But is it really excessive?
Compared to who?
 A recent study reports an average total compensation of about $9
million for CEOs in the country’s largest companies… not much
compared to the highest paid male sports star.
1. Tiger Woods, golf $78 Million.
2. Roger Federer, tennis, $72 Million
2. Kobe Bryant, basketball $62 Million
2. Lebron James, basketball $60 Million
5. Drew Brees, football $51 Million]
34
Is it really excessive?
Compared to who?
 The average pay for a CEO in the Fortune 500 was about $10.5
million
 The CEOs of America's 500 biggest companies received an
aggregate total compensation of about $5.25 billion in 2012.
 The highest paid CEO was John H. Hammergren of health-care
company McKesson, according to Forbes who received total
compensation of $131.2 million .
35
 Last year, The total compensation
for the 500 CEOs in the Fortune 500
in aggregate was about the same
as the TOP 3 hedge fund managers!
Compared to who?
36
Is it really excessive?
Or pay for performance?
 Studies of publicly traded companies show that increases in CEO pay
in general closely mirror the financial performance of their companies.
 Studies show in general a strong correlation between CEO pay and
company performance in their market sector.
 There is also in general a strong correlation between CEO Pay and
total shareholder return.
 That’s pay for performance…… isn’t it
37
Is it really excessive?
What do you think?
38
Questions

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Is Executive Pay Excessive

  • 1. Executive Compensation: Is it Really Excessive? James Sillery Adjunct Professor John Marshall Law School
  • 2. 1 Overview  Over the last few decades, there have been clear points in time where almost everything in executive compensation has changed.  Today, we are seeing a fundamental redesign of executive compensation with much more change to come.  Shareholder activism has increased scrutiny of executive compensation, resulting in regulatory and legislative changes.  Companies are rethinking how they pay for performance and what performance they should pay for.  The global recession and resultant stock market volatility has changed the companies and executives think about equity compensation  Companies are now being challenged to do more than just react to these changes!
  • 3. 2 Executive pay  Who are executives?  Why is executive pay different?  What makes up an executive pay package  Why is everyone talking about it?  What are the current drivers and trends?  Is it really excessive?
  • 4. 3 Who are executives?  An “officer” as defined in Rule 16a-1(f) under the Securities Exchange Act of 1934, and includes the president, the principal financial officer, the principal accounting officer, any vice president in charge of a principal business unit, division, or function (such as sales, administration, or finance), any other officer who performs a policymaking function, or any other person who performs similar policymaking functions for that company. OR  More simply, those few key employees responsible for the professional management of the company.
  • 5. 4 Why is executive pay different?  High impact.  High visibility (inside and outside the company).  Pay for performance: high upside/high risk/high scrutiny.  Impacted by tax, accounting, legislative and securities exchange considerations  Covered by regulations limited to a specific group: – Section 162(m): $1 million cap on compensation – Section 280G: Golden parachutes – IRC Section 4958: Non-Profit Executive Pay
  • 6. 5 What makes up an executive pay package?  Cash Compensation – Base salary – Short-term performance incentive/discretionary bonus  Deferred compensation/capital accumulation  Long-Term Incentives (cash and equity)  Executive perquisites and benefits  Executive agreements – Severance – Change-in-control
  • 7. 6 General practices  Base salary as a percentage of the total compensation mix has decreased significantly over the past decade.  The practice of providing for benefits remains relatively flat.  There continues to be a greater emphasis on aligning pay and performance through short and long-term incentives.  Long-term incentive compensation continues to be a major component of executive compensation programs in publicly traded companies.  To compete, privately held companies are more often implementing long-term plans that look and act like those in publicly traded companies.
  • 8. 7 Cash compensation  Growth in base salaries continue to moderate.  Research shows that salary increases for executives has averaged slightly higher than average increases for employees.  Companies continue to shift compensation from fixed elements, such as base and benefits to performance–based variable compensation.  The most common form of short-term incentive for executives is a management annual incentive plans – Participation is limited to top positions, a group pool is funded based on pre-established criteria and awards are distributed based upon company, group and/or individual performance.
  • 9. 8 Deferred compensation  Non-qualified benefits are playing a greater role due to the declining percentage of compensation deferrable under 401(k) as income increases. 25.00% 17.50% 11.66% 8.75% 7.00% 5.83% 5.00% 4.37% 3.88% 3.50% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% $70,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 $500,000 Annual Compensation 2013 Maximum Pretax Deferral is $17,500
  • 10. 9 Long-Term Incentives: Stock Options  Grant of 10,000 options on shares selling at $10.00 at date of grant.  Scenario A: stock option results in a gain of $15.94 per share/$159,400 in total: – Executive pays a $100,000 exercise price (10,000 x $10). In return, executive receives stock worth $259,400 (10,000 x $25.94)  Scenario B stock option is worthless, or underwater: Executive can purchase stock at $3.49 on the open market. $0 $5 $10 $15 $20 $25 0 1 2 3 4 5 6 7 8 9 10 gaingaingaingaingain $15.94 gain $3.49 Date of Grant Date Fully Vested Date of Exercise A B $25.94 $10  A stock option is the right to purchase stock at a stipulated price over a specified period of time.
  • 11. 10 Long-Term Incentives: Restricted Stock  Grant of 10,000 restricted shares selling at $10.00 at date of grant.  Scenario A: Executive receives full value in shares when they vest; worth $259,400 (10,000 x $25.94)  Scenario B Executive receives full value in shares when they vest; worth $34,900 (10,000 x $3.49) $0 $5 $10 $15 $20 $25 0 1 2 3 4 5 6 7 8 9 10 gaingaingaingaingain $15.94 gain $3.49 Date of Grant Date Fully Vested Date of Exercise A B $25.94 $10  Executives receive an outright grant of shares at no cost to the executive, subject to meeting certain requirements.
  • 12. 11 Long-Term Incentives: Performance Share  The number of shares earned is determined by performance relative to financial and/or share price performance. Performance Share Plan Example: Participant is awarded 20,000 shares, earned out over a three year performance period Actual Shares Earned out over 3 Year Period Award Maximum 150% 30,000 20,000 Target 100% 20,000 Threshold 50% 10,000 If performance is below Threshold, no shares are earned. Actual award of shares is pro rated, e.g., at 125% performance, 25,000 shares are earned
  • 13. 12 Realistic Assumptions: What the Model Implies Versus What Has Happened We have ample evidence that our foundation and models for describing securities returns and corresponding drivers do not adequately explain what we have seen over the last 25 years… …But we also don’t have an adequate replacement foundation and set of models
  • 14. 13 Understanding the value of equity compensation is becoming more complex Log-Normal Random Stock Prices Mean = 10% Volatility = 20% $0 $100 $200 $300 $400 $500 $600 0.0 0.4 0.8 1.3 2.1 2.5 2.9 3.3 3.8 4.2 4.6 5.0 5.4 5.8 6.3 6.7 7.1 7.5 7.9 8.3 8.8 9.2 9.6 10.0 Time (Yrs) StockPrice 4,2 4,3 4,4 4,1 4,0 5,3 5,2 5,4 5,5 5,1 5,0 1,0 1,1 2,2 2,1 2,0 3,3 3,2 3,1 3,0 0,0
  • 15. 14 Or has the market just changed the rules?  At lower levels of the organization, restricted stock is more highly valued while executives valued the upside stock options can offer.  Restricted shares initially have a higher value, but there is a cross over point where stock options offer greater opportunity. $0 $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 $1,400,000 1 2 3 4 5 6 7 8 9 10 Comparison of Delivered Value of Stock Options to RSUs Stock Options RSUs
  • 16. 15 Perquisites  There has been a general decline in the number of perquisites offered to executives, largely the result of changes in legislation that eliminated the tax-favored treatment to executives, as well as increased media focus on “personal” perquisites – the “Jack Welch Syndrome”. 0% 10% 20% 30% 40% 50% 60% 70% Company Car or Allowance Financial Counseling Legal Counseling Club Memberships First Class Air Travel VIP Lounge Memberships Spouse Travel Expenses Special Dining Facilities Executive Perquisite Practices CEO Tier 1 Tier 2
  • 17. 16 Executive Agreements  It is common practice for executives to be covered by employment agreements.  These provide the terms of employment, e.g., salary, bonus, position, perks, etc.  They also provide protection in the event of termination.  They are often viewed as necessary to recruit executives.  Several aspects have become controversial: – Severance, usually one times base plus bonus for a CEO. – Change-in-Control, usually 2-3 times base plus bonus and acceleration of equity grants for a CEO. – Gross ups keep the executives whole for taxes and/or penalties.
  • 18. 17 Who sets executive compensation?  Public Companies vs. Private Companies – Compensation consultants - provide advice – CEO - recommend/approve – Compensation committees – recommend/approve – Boards of Directors – recommend/approve – Shareholders/Owners – approve
  • 19. 18 Why is everyone talking about it?  In the early 1980s, executive compensation – including base bonus and equity – began to rise faster than the earnings of the average worker.  CEO compensation has grown the fastest, peaking in 2000 at the peak of the stock market bubble.
  • 20. 19 Why is everyone talking about it? “Greed is Good!”
  • 21. 20 Why is everyone talking about it?
  • 22. 21 Topics and Trends in the Headlines Corporate scandals – executive compensation visibility SEC – New disclosure requirements mandating increased transparency and quantification Governance – How should executive pay be approved… and who should approve it FAS 123R – Accounting costs influencing reward mix New rounds of regulations and legislation placing limits on executive pay Topics • Pay limits • Incentives and risk • Pay for failure • Repayment of bonuses • Escrowed bonuses & bonus banks • Lack of alignment with shareholders Trends • Say on Pay • Clawbacks • Option exchanges • Executive pay cuts • Gross-up retrenchment • Performance plans • Emergence of advisory firms (ISS/Glass-Lewis) Caveats • Focused on Pay for Performance Alignment • Focused on largest companies • Actions driven by compliance and concession • Little focus on innovation
  • 23. 22 Trend #1: Greater Scrutiny  Public outrage over excessive executive compensation (real and perceived) has continued without slowing down…
  • 24. 23 Trend #1: Greater Scrutiny  Prior to the last recession, we saw increased scrutiny of practices regarding the timing of stock option grants, prompting an investigation by the SEC into “backdating” practices at 264 companies.  Backdating allows executives to choose a past date when the market price was low, thereby inflating the value of the options. – Backdating is illegal and also unnecessary since the problem could have been avoided by granting discount stock options.  Other practices are not illegal, just unethical since it is questionable whether shareholders knew that this was going on, and if not, whether they would have approved of it. – Granting options shortly before announcing good news in this way is called “spring-loading”. – Delaying a grant until after bad news is announced is called “bullet- dodging”.
  • 25. 24 Trend #1: Greater Scrutiny  Other Hot Buttons: – Performance: Pay should be supported by performance consistent with articulated strategy and objectives. Non-performance should not be rewarded! – Severance: Severance and termination benefits must be “reasonable” and consistent with the purpose that the company is trying to achieve. – Perquisites: Perquisites have come under increased scrutiny, especially where they are for “personal” benefit, such as use of corporate aircraft, spouse travel, etc. – Supplemental Benefits: Shareholders want full disclosure of nonqualified deferred compensation plans, particularly when there is a “preferred or above market” interest being paid. – Change in Control and Gross Ups: Should the company be footing the tax bill for excess parachute payments?
  • 26. 25 Trend #1: Greater Scrutiny  Paying the Piper: – Former Brocade CEO Gregory Reyes was convicted on conspiracy and securities fraud charges. – Adelphi Communications founder John Rigas and his son Timothy began prison sentences for conspiracy, securities fraud and bank fraud. – Former Hollinger International Chairman Conrad Black was convicted of fraud and obstruction of justice. – Sanjay Kumar, the former head of CA, has begun his prison sentence for securities fraud and obstruction of justice. – Former WorldCom founder Bernard Ebbers and former Enron CEO Jeffrey Skilling are serving prison sentences for securities fraud. – Former Qwest CEO Joseph Nacchio is serving a prison sentence for insider trading. – In one of the largest corporate pay give-backs ever, William W. McGuire, former CEO of UnitedHealth Group, forfeit $618 million to settle claims related to back-dated stock options.
  • 27. 26 Trend #2: Greater Disclosure The SEC disclosure rules impose:  A codification of how and what executive pay data will be disclosed in the proxy  A high expectation about how that data are expected to inform compensation decisions Their intent was to provide:  A clearer and more complete picture of the compensation earned by a company’s leadership (executives and directors)  Insights into the compensation decision-making process
  • 28. 27 Trend #2: Greater Disclosure (Round 1)  Top Five Highest Paid Executives were redefined.  Objective was to provide wage clarity in “plain English”.  Report a single compensation dollar figure (“One Number”).  Dollar value of equity grants in the summary compensation table.  Disclosure threshold for perks was reduced to $10,000.  Specify payments in event of severance/change in control.  New disclosure table for retirement and NQDC plans.  New director compensation table.
  • 29. 28 Trend #2: Greater Disclosure (Round 2)  Creates a new section in the CD&A to discuss and analyze “risks arising from those compensation policies or practices may have a material effect on the company.”  Requires the value of stock and option awards disclosed to be determined using the aggregate grant date fair value under FAS 123R rather than the current dollar amount for financial statement reporting.  Expands the disclosure requirements to include the relevant experience and qualifications of directors and nominees and other directorships held.  Requires disclosure of the company’s leadership structure to increase the transparency for investors as to how boards function. – Whether the CEO and board chair roles are combined or separate. – If the roles are separate, whether there is a lead independent director. – Disclosure of the board’s role in the company’s risk management process, including credit, liquidity and operational risks.  Disclosure of Consulting Fees to Compensation Consultants
  • 30. 29 Trend #3: Less Flexibility  With the passage of the “American Jobs Creation Act of 2004”, IRS Code Section 409A was created to govern all deferred compensation arrangements. Earlier this year, the final rules were issued.  IRC Section 83 vs. IRC Section 409A – Current cash compensation is treated as ordinary income at the time that it is received. – IRC Section 83 governs the transfer of property, including the equity in a company. – IRC Section 409A now covers the “gray area” that had existed between the two.  To the extent that IRC Section 409A’s strict operational and documentary requirements are not satisfied, the deferral is considered “defective” and is generally currently taxable, with interest, and must pay an additional 20% tax penalty.
  • 31. 30 Trend #3: Less Flexibility  Section 409A of the Internal Revenue Code of 1986, as amended (“Code Section 409A”) is broad in scope and has proven to be difficult for even the most well-intentioned employers to satisfy.  Any employer which maintains non-qualified deferred compensation plans for its employees has struggled with Code Section 409A, and may have concerns that some of its plans might not satisfy the attention to minutiae that Code Section 409A demands.  On January 4, 2010, the IRS published its long-awaited program for correcting documentation failures under Code Section 409A.  Notice 2010-6 is broken into two component sections. – First, Notice 2010-6 explains that certain ambiguous plan terms will not be deemed to violate Code Section 409A. – Second, Notice 2010-6 lists several specific types of document failures, and describes applicable correction procedures for each.
  • 32. 31 Trend #4: Dodd-Frank Act  Major provisions of Dodd-Frank related to compensation addressed the following areas: – Say on Pay – Golden parachute payments – Independence of Compensation Committees – Executive Compensation Disclosure – Clawbacks – Executive and Director Hedging
  • 33. 32 CEOs are highly compensated… … But is it really excessive?
  • 34. 33 But is it really excessive? Compared to who?  A recent study reports an average total compensation of about $9 million for CEOs in the country’s largest companies… not much compared to the highest paid male sports star. 1. Tiger Woods, golf $78 Million. 2. Roger Federer, tennis, $72 Million 2. Kobe Bryant, basketball $62 Million 2. Lebron James, basketball $60 Million 5. Drew Brees, football $51 Million]
  • 35. 34 Is it really excessive? Compared to who?  The average pay for a CEO in the Fortune 500 was about $10.5 million  The CEOs of America's 500 biggest companies received an aggregate total compensation of about $5.25 billion in 2012.  The highest paid CEO was John H. Hammergren of health-care company McKesson, according to Forbes who received total compensation of $131.2 million .
  • 36. 35  Last year, The total compensation for the 500 CEOs in the Fortune 500 in aggregate was about the same as the TOP 3 hedge fund managers! Compared to who?
  • 37. 36 Is it really excessive? Or pay for performance?  Studies of publicly traded companies show that increases in CEO pay in general closely mirror the financial performance of their companies.  Studies show in general a strong correlation between CEO pay and company performance in their market sector.  There is also in general a strong correlation between CEO Pay and total shareholder return.  That’s pay for performance…… isn’t it
  • 38. 37 Is it really excessive? What do you think?