33 Reasons That Your Company’s Say-on-Pay Vote Might Go Sub-50% in 2013

Fred Whittlesey

Compensation Venture Group, Inc.

News of companies that failed their say-on-pay vote is in the headlines almost daily this time of year.  What don’t make the headlines are stories of the companies that barely passed (in the 50% to 70% range) or that passed but plummeted from their 2011 approval levels.  Many in the former category last year failed this year.  Many in the latter category this year may fail next year.

While additional data will continue to trickle in over the summer, my firm has completed research on the first 54 failed say on pay votes in 2012, finding:

• Only four of the companies that failed this year’s SOP vote also failed last year. The other 50 companies that failed this year had an average approval rate of 78% last year with approval levels ranging from from 50% to 99%.
• 13 companies that passed the 2011 SOP vote with percent approvals in the 90’s – probably feeling like the issue was over – failed in 2012, averaging a 38% approval – no different from the average of other failing 2012 companies that had 2011 approval levels of 50% to 89%.
• Votes on replenishment of shares in equity incentive programs among the failing SOP firms ranged from 100% down to the one company that failed the additional shares request (37%) as well as SOP (33%).
• Increasingly, the Compensation Committee members are failing to attract a strong majority “for” vote – if SOP and equity votes don’t get their attention, a personalized message typically does.   Many that were re-elected did so with an approval level in the 60s and 70s. We have seen how that can trend.
• In one company that has a triennial, rather than annual, SOP vote the shareholders who couldn't vote against executive pay instead voted against all three Compensation Committee members, who failed to get majority support.
• The moral to the story: Don’t be complacent about an SOP success – even at 99% - in any given year.  Several companies whose programs received ISS’s blessing last year saw that opinion reversed on the identical pay program this year, because ISS changed the rules which they may do again next year.

Do You See Your Company's Equity Program Features on This List of 33?

There has emerged a consistent set of issues that have led Institutional Shareholder Services, Glass Lewis, and others to recommend an “against” vote and these are central to the steep decline in approval experienced by the companies failing. Most of these apply to executive awards, but some apply to broader programs. Here they are, in no particular order:

• Grants of stock options (not performance-based pay!)
• Grants of time-vested RSUs
• Large “retention” awards (2 or 3 times normal annual grant size)
• Time-vested stock options granted with a strike price at current fair market value
• Performance-vested awards without sufficient “rigor” of the goals
• Lack of disclosure needed to assess the rigor of goals
• Performance awards that payout at the maximum level several years in a row, indicating a potential lack of rigor
• Granted pay (per the Summary Compensation Table, the majority of which is equity) that is not aligned with total shareholder return in previous years…even though “realized pay” is aligned
• Performance measures for equity awards that are qualitative (e.g., synergy, leadership)
• Performance measures for equity awards that are quantitative but use nonfinancial measures (e.g., safety, quality) which are not externally auditable and verifiable
• Using the same performance metrics for  both the annual and the long-term incentive plans
• Using non-GAAP performance measures (e.g., adjusted EBITDA) that are not clearly reconciled to GAAP numbers
• Overlapping goals in performance awards
• Unreasonably low performance thresholds and targets for performance awards that assure payout
• Payout opportunities for performance below the peer group median performance (e.g., performance at the 25^th percentile that pays 50% of target)
• Use of subjectivity or discretion in determining award payouts, as an element of the plan design
• Modifying performance goals mid-cycle when the goals will certainly be missed
• After-the-fact discretionary override of missed goals to provide a performance award payout due to external circumstances
• Use of “either-or” performance measures that appear to ensure a payout
• Short-term (e.g., annual) performance periods within a multi-year plan
• Carryforward and/or carryback features in a performance plan
• Payment of dividends/dividend equivalents on unearned or unvested awards
• Inclusion of equity awards in pension or SERP calculations
• Tax gross-ups
• Lack of stock ownership guidelines or retention requirements on equity awards
• Large grants of RSUs in the same year that stock ownership guidelines are implemented, assuring that upon time-based vesting the aftertax shares will be sufficient to meet the guideline
• Lack of a clawback policy (even though the SEC hasn’t met their deadline for issuing clawback rules)
• Inadvertent timing of grants and the recognition of an accounting grant date, creating the appearance of a large “pay increase” year-over-year
• Single trigger, or modified single trigger, change in control provisions for equity grants
• No disclosure of holding periods for shares from exercised options and RSU/performance RSU awards
• Excessive “concentration” of equity grants in the year among the NEOs (NEO combined grant value as a percent of total grant value to all employees)
• Inadequate disclosure regarding the equity compensation program when requesting additional shares - which led to a judge prohibiting the vote at one company that reconvened the meeting later and received only 59% support
• And finally, ignoring last year's criticisms of the equity compensation program because the SOP approval rate was satisfactorily high

Of course, some of your company's equity program features are on this list. This is the problem.  It is impossible to design an equity compensation program to meet all investors' and proxy advisers' policies and standards, include design features that make sense from strategic, financial, behavioral, and governance points of view and reflect sound business judgment by the Compensation Committee but nevertheless may be the trigger for a "no" recommendation on SOP, the equity plan, and/or the Committee members.

And the best plan design in the world may not be enough if your total shareholder return is negative or below that of your peers, and your investors are grumpy about that.

There are many other executive compensation issues that are not specific to equity compensation but are potential triggers of a negative recommendation from proxy advisers and institutional shareholders.  This brief list above is limited to those that directly affect equity compensation practices.

I’ll be discussing these issues in depth in the next "Ask Fred" EASi webinar on 19-July: 

Say-on-Pay 2012:  The Effects on Equity Plan Design

With much of the 2012 shareholder meeting season having passed, we have the opportunity to review how the second year of say-on-pay in the US is influencing equity compensation program design. While often discussed as an executive compensation issue, one of the central themes in shareholder voting influences continues to be equity compensation.  In fact, the approval rates for new equity plans and additions of shares to existing plans are declining compared with previous years.  In some companies, voting outcomes are revealing more dissatisfaction with the equity plan than with executive pay.  This session will review what companies experienced in 2011, how that changed in 2012, and what will continue to evolve as companies are already preparing for the 2013 season.


Register here for this session

The Executive Compensation Controversy: What it Means for Equity Compensation in 2012

As we approach the 2012 proxy season - the months of March, April, and May when about 70% of public companies file their proxies for this year's shareholder meeting - we provide an update on a number of significant developments. Over the past few months, a series of changes in proxy adviser policy, regulatory timelines, media coverage, and the political landscape are converging to ensure another controversial year for equity compensation.

The headlines will focus on the topic of "executive compensation" but in fact many of the issues are driven by equity compensation and will have a direct impact on companies' equity compensation granting practices in 2012.

On February 2 at 10:00 AM PST, I will be hosting a webinar covering various issues related to executive compensation, including:

• Why the second year of "say on pay" may pose more problems for companies than the first year, and how #1 issue in investors' minds is not executive pay - it's equity compensation
• How a new focus on pay-for-performance "alignment" for the CEO - a calculation driven by, and distorted by, equity compensation valuation - will force some companies to redesign their plans
• Why the headlines about "CEO pay cuts" and "record CEO pay" are rooted in misunderstanding of equity compensation values and provisions and will require proactive communication to investors...and employees
• Why the carefully constructed peer group you use for compensation comparisons may have just become irrelevant for equity compensation purposes
• How the SEC's delay in implementing the Dodd-Frank "CEO Pay Ratio" and "CEO Pay for Performance" rules has led the private sector to forge ahead with the concepts
• Why companies will need to develop more sophisticated grant allocation methods and systems to balance increasing pressure on dilution and the growing complexity of plan design

This webinar is hosted by Equity Administration Solutions, Inc. (EASi)

Register today to participate in this informative session!

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:

"Who are your peers?  The SEC Wants to Know"

"The New Era of Equity Compensation:  Performance Plans"

"The Return of Cash Long-Term Incentives"

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.

Executive Pay: What is Not Said

"You have to listen to not only what is being said, but what is not said -- which is often more important than what they say." — Kofi Annan

There may be daily updates on this issue because I am reading, daily, misreporting of executive pay. This time, it's the Washington Post and it's about what was not said.

Capital One Chief Was Paid $17 Million in 2007
Capital One, the McLean credit card issuer, awarded chairman and chief executive Richard D. Fairbank a pay package it said was worth $17 million last year, almost entirely stock options. That compares with a package worth $18 million in 2006, the company said. Fairbank last year exercised stock options at a gain of $54.8 million, the company said. That sounds heroic, a CEO just getting paid from gains received by shareholders.

They got the "awarded" part right. Of course the $17 million number is likely a significant understatement of the value of those options but that has been in this blog before and will be again, but not right now.

The problem here is what was not said. It is true that he had a gain of $54.8 million on options. But as the media continues to miss the significant change in executive equity compensation packages, this reporter missed a little $18.3 million vesting event on restricted shares, understating pay by about 25%.

Now, there is another complexity here. A footnote indicates that:

"Values reported for Stock Awards are related to the vesting of Mr. Fairbank’s performance shares on March 31, 2007, delivery of which are deferred until the end of Mr. Fairbank’s employment with the Company. Therefore, Mr. Fairbank neither acquired any shares nor realized any value from such shares in 2007." Not true. If someone gives me $18 million in stock but I've told them to just hang onto it until I retire, it is difficult for me to argue that I didn't "realize any value" from that. That is a tax technicality.

This further highlights not only the complexity of executive pay but the need to understand both the tabular disclosures and the voluminous footnotes. And the accounting, the tax, and the other technical nuances.

What was not said here is important: When Capital One's stock price was flat for two or three years their interest turned to giving executives free shares of restricted stock. Now that the stock has lost half its value, how attractive those stock options look again so the executives can participate in the rebound. Flat price, guaranteed pay. Low price, guaranteed participation in the rebound. (See previous posts on Washington Mutual for the popularity of this approach.)

That's the real story, Washington Post. With your reputation for investigative journalism, how about spending a little more time on the shenanigans going on in the financial services industry right now. We are seeing various combinations of fraud, failure, and folly and even the least serious of those is an important corporate governance issue. Directors are paid to prevent folly, and not be a part of it.

New Issue of The Compensation Committee Adviser

Beware the Compensation Headlines: Apples and Oranges

I have often said that when one reads an article about executive compensation in any of the leading business publications – the Wall Street Journal, Business Week, Forbes – one should assume that the pay amounts cited are incorrect. While they are not always incorrect,...

To keep reading, click here: http://compensationcommitteeadviser.blogspot.com/

Pay Granted, Earned, and Paid: Bubble, Bubble Toil and Trouble?

by Fred Whittlesey
Compensation Venture Group, Inc.

The actual line from Macbeth was, of course, “Double, double toil and trouble.” Factual documented information often gets twisted into a widespread misunderstanding. And so we have executive pay.

For the past twenty or more years the media have reported executive pay as a “story” worth covering. This has escalated over the past few years as the topic has moved from the business section to the front page. There are a couple of reasons for this. First, the numbers are bigger. Apparently it’s more interesting to read that someone was paid $210 million than it is to read that someone was paid $10 million. Second, the reason for the pay has changed. $210 million for getting fired versus $10 million for running a successful company does indeed have a human interest angle.

But where do these numbers come from and how do we know they are right? The answers to that compound question are “the proxy statement” and “we don’t.” The SEC’s new proxy disclosure rules changed the Summary Compensation Table (SCT) from a report of apples (dollars earned and paid), oranges (dollars contingently paid), and bananas (stock options granted – the number, not the value) into a recipe for vegetable stew (accounting expense) – which would be alright if we were looking for vegetables, but we were really wanting to know about fruit.

Here is the root of the problem:

Most compensation professionals were trained, and continue to believe, that the amount granted in a single year, regardless of contingencies for future vesting or performance, is “pay” for that year. We do need to value those grants. By way of example, Steve Jobs, CEO of Apple was “paid” only $1 (there are no missing zeroes, there, just one dollar) in 2006. He received no bonus, no stock option grants, no stock awards. Just a buck.

The new SCT portrays what the accountants recorded as an accrued (read: estimated or hypothetical) and thus earned expense for the year. Some joke that the SCT now stands for “Summary Cost Table” but it is not that either unless your only view of “cost” is accounting expense and shareholders are move savvy than that. We do need to decide if the accounting numbers are useful in valuing those grants. Under this method, Steve Jobs was paid $1 plus the portion of the $577 million in restricted stock that he “earned” during the 2006 fiscal year. We'll know that number when Apple files their next proxy under the "new rules."

The media, of course, like to report what was paid, even if that represents an accumulated amount based on 10 years of work. Those big numbers sell newspapers. I think we can conclude that these numbers are far removed from any single year’s grants. Under this method, Steve Jobs was paid $577 million in 2006...oops, $577,000,001. We could talk about Mr. Jobs other job, as CEO of Pixar, or his Gulfstream, but we'll leave those for another blog day.

The Jobs/Apple example is extreme enough that it invites more scrutiny. But what about the CEO of one homebuilder whose three numbers for 2006 are $2,015,499 granted, ($2,296,918) earned, and $7,903,997 paid. Negative compensation? That guy must have had a really poor year but fortunately was “paid” almost $8 million in a year in which he “earned” negative $2 million.

This can make one feel like all of this data more witches’ brew than vegetable stew, and impossible to digest. Compensation professionals have never faced such a large amount of such confusing information. I think it is a fair estimate to say that it is at least “double double toil and trouble” to analyze executive pay. Shakespeare saw it coming.

It’s critical that a company and its Compensation Committee take a position on how pay is measured and use that consistently in benchmarking, analysis, and the decision process. An appropriate data collection strategy focused on the most recent data available, combined with attention to details of compensation design, will cut through the confusion and tell the correct story. Data from SEC filings is the most valuable and most accurate data available for executive pay, and it’s worth the toil and trouble.

Next blog: An example of the measurement problem