Fred Whittlesey
Compensation Venture Group
"There'll be scary ghost stories
And tales of the glories of...
Long, long ago"
-Edward Pola and George Wyle
as performed by Andy Williams (1963)
"It's the Most Wonderful Time of the Year"
Yes, it's the most wonderful time of the year - Compensation Committee season!
As Committees gather to review 2011 and plan for 2012, we have a record number of scary ghost stories this year - with the first year of say-on-pay, several dozen failed votes, and a handful of lawsuits, all rooted in ghosts of decisions of Compensation Committee meetings past. With that comes the inevitable yearning for the glories of long, long ago. Not so long ago, really. Maybe five years since Compensation Committee decisions starting getting really complicated, with the past year attaining a new level of complexity.
These discussions typically commence with the topic of the peer group. Is the peer group still relevant? Did we lose many peers over the past year due to M&A activity? Have we considered the peer group criteria of external parties? Have we used the "right" industry codes and metrics to define the group? Did we use a defensible process for determining our peer group?
We've moved from a time of shareholders and proxy advisers merely opining on pay versus peers, to one of their opining on the peers themselves. The media have caught on to this topic, with the Tootsie Roll story in the Wall Street Journal back in 2009, and more recently the Washington Post "Cozy Relationships" article.
Thank goodness, Institutional Shareholder Services has come along with their annual holiday treat, their 2012 Policy Updates. The U.S. policy updates are a particular treat, with ISS informing us that they are going to extend their helpfulness by not only critiquing companies' peer groups as disclosed in the proxy statement, but now creating a personalized peer group for them:
"The peer group is generally comprised of 14-24 companies that are selected using market cap, revenue (or assets for financial firms), and GICS industry group, via a process designed to select peers that are closest to the subject company, and where the subject company is close to median in revenue/asset size. The relative alignment evaluation will consider the company’s rank for both pay and TSR within the peer group (for one- and three-year periods) and the CEO’s pay relative to the median pay level in the peer group."
This will purportedly help ISS to assess "peer group alignment" for the pay-for-performance assessment. The magic number of "14-24 companies" must be a scientifically-derived improvement over the range of "15-25 companies."
We also have on our holiday wish list the proposed guidance from the SEC on clawbacks, the CEO pay ratio, and the CEO pay-for-performance analysis. They never let us down with these year-end pronouncements.
These rules will put still more pressure on the peer group process as various parties - including the media - opine on the CEO pay ratio versus other companies and the CEO pay-for-performance analysis versus other companies (and maybe yet another peer group). We'll see companies publish supplemental tables to push back on the SEC's required disclosures, all of this rooted in the peer group issue.
That is the ghost of Compensation Committee meetings future. Happy Holidays.
Wednesday, November 30, 2011
Saturday, November 19, 2011
Fixing the Executive Pay Problem, 1990-2011
Every week I receive a Giga Alert, pointing me to where I have been posted, cited, or referenced. Some of these represent a chain going back quite far. Today I received one citing an article published by Rutgers University in 1992 that mentions an editorial I wrote for the Sunday Los Angeles Times in 1990. I hadn't read that piece, or even thought of it, for quite some time. 21 years later, not much has changed. See the original here, or keep reading.
Fixing the Executive Pay Problem : Compensation: Improvements must come in incentive programs that link pay to performance, with an emphasis on long-term stock benefits instead of quick cash.
EXECUTIVE PAYCHECKS. California's Rising Sums: First in a series.
Fixing the Executive Pay Problem : Compensation: Improvements must come in incentive programs that link pay to performance, with an emphasis on long-term stock benefits instead of quick cash.
EXECUTIVE PAYCHECKS. California's Rising Sums: First in a series.
What should be done, if anything, about the seemingly excessive executive pay in U.S. corporations? The answer, while technically simple, is difficult to implement.
Most economic and financial theorists agree that a senior executive's job is to maximize long-term shareholder value. If this is correct, then the executive's pay should be maximized when shareholder value is maximized.
If boards of directors are to design such programs, then the improvements must come in so-called incentive compensation programs--such as annual bonus plans and stock options--that link pay to performance. It is these programs--not salaries, benefits and perquisites--that are creating the highest compensation levels. These incentive programs deliver two forms of compensation: cash, mostly from annual programs, and stock, mostly from long-term programs.
Unfortunately, most annual cash incentive plans are based on such measures as pretax profit, return on equity and other financial measures that encourage short-term maximization and are easily manipulated by savvy executives. A large body of financial research indicates that better measures are available that ensure that shareholders' capital is earning an adequate return. Incorporating these measures into annual incentive plans will improve one element of the total executive compensation situation.
The current use of stock options and stock-related compensation programs is consistent with the goal of increasing shareholder value. If structured properly, stock-based compensation should not ruffle shareholders' feathers because their fates will be linked with that of executives. When an executive's share holdings far exceed any benefit or risk derived from cash compensation programs, shareholders' interests will be maximized.
The abuses tend to come when various "bells and whistles" are added to already potentially lucrative stock programs. And these are easily remedied:
* Eliminate stock appreciation rights. SARs allow an executive to get a cash bonus when the stock price goes up. While this objective seems noble, the cash payment allows an executive to profit from temporary rather than long-term stock price increases.
* Require executives to hold stock options for a longer period before cashing out. Most plans allow executives to begin exercising stock options as soon as one year after receiving them and continuing over a three- to five-year period. By extending these schedules, the executive has a true long-term incentive to maximize share price.
* Require the executive to continue holding shares acquired through stock option and stock award plans. This would truly align executives' interests with shareholders' interests. These holding periods can allow for some cashing out along the way, but only when stock value is maintained or increased. Without holding periods these stock plans can become just "quick cash" programs.
* Eliminate the cancellation and reissuance of options. When an executive receives an option and share price drops soon after, an option may not be "in the money" for some time. Most options usually give an executive the right to buy stock at a price close to the market price when the option is granted. So if the stock price then goes up, the option becomes more valuable, in effect allowing the executive to purchase stock at a discount. But if the price goes down instead, the option is essentially worthless.
Many companies have solved this problem by canceling the old option and reissuing it at the lower price. Unfortunately, a shareholder who bought a share at the higher price does not have the same opportunity. It is difficult to imagine a situation in which a cancel or reissue is truly warranted, particularly if companies follow rational option-granting policies.
* Grant large options at the beginning of a period and eliminate annual grants. If on the day a senior executive is hired or promoted, he or she received 10 years' worth of stock options and the options could not be exercised for 10 years, the executive's perspective would be much longer term. The practice of making annual option grants encourages a short-term cash-out mentality.
* Consider paying executives only in stock, with special arrangements to provide the necessary cash flow for living expenses. If all other compensation is in stock, then dividends, selective liquidation programs and company loans can eliminate the need over time for any base salary or bonus plan. In the transition, a well-designed annual incentive program should provide all the cash necessary for a well-funded executive lifestyle.
The obstacles to implementing these shareholder-oriented compensation programs are not technical in nature. The obstacles are timid boards of directors, relationships between consultants, and executives that prevent objectivity and objections by executives who benefit from the current programs.
With improved board scrutiny and timely redesign of compensation programs, the executive compensation controversy will end to all parties' satisfaction, with the exception of those poorly performing executives who were excessively paid under the old schemes. In absence of such action, there is the risk that the government will step in to curb the perceived excesses.
Saturday, November 12, 2011
About Four Years Ago
Fred Whittlesey
Compensation Venture Group, Inc.
I was updating my website this weekend, and revisited some "old" articles I had authored. Way back in late 2007 through early 2008.
The field of equity compensation has gone through such tremendous upheaval over the past four years, I was ready to delete these links until I pondered for a moment the titles, that could have been written and be relevant just this week:
Because these were all written at the time for Salary.com (now Kenexa) where I was a Fellow, whatever that is or was, I can't update them, per se.
Then I read them, and realized they hardly need updating. In fact, the premise of each has been strengthened over the past 4 years and there are even more pressures on the three topics. Sure, the data references need to be recent and there are more inputs to the issue - primarily the new Dodd-Frank disclosures (CEO pay ratio and CEO pay-for-performance).
Consider, since 2007/2008:
- Investor, proxy adviser, and SEC scrutiny has extended from how executives are paid versus peers, to which companies are actually in the peer group and how that peer group was determined.
- Performance plans, somewhat avant garde back in 2007, are fast becoming a mandated approach in the US as we are now in the say-on-pay era - exactly the pattern we saw in the UK with the advent of say-on-pay. Now this solution has become yet another problem, as I have written and presented on.
- And cash long-term incentives, still under the radar due to compensation survey firms' and proxy data services' inadequate tracking of them, are growing in prevalence faster than reported, due to the odd combination of shareholder concerns about dilution and many companies with large amounts of cash on their balance sheet.
Taken together, these issues create chaos for trying to understand how much an executive was "paid" so that everyone can chime in on whether the number is just too big, too big relative to the average worker, and/or too big relative to company performance. When very different forms of compensation are awarded, we run into the issue of "granted" vs. "earned" vs. "realizable" vs. "realized"...and more.
Each of these three written pieces deserves an update, I mean a fresh authoring, which I will do over the next few weeks. While I'd like to pat myself on the back for being prescient on these issues, I think we all should have seen these three things coming and now we have even more to discuss.
Anyone want to predict what we'll be discussing in 2015? Yikes.
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