Developments in Executive and Director Pay

Developments in Executive and Director Pay: Take Aways from Society of Corporate Secretaries’ Spring Conference for the Mid-Atlantic Chapter

June 10 2013

On June 3, 2013, we participated in a panel on Developments in Executive and Director Pay at the Society of Corporate Secretaries’ Spring Conference for the Mid-Atlantic Chapter.  The panel covered a wide range of current topics pertaining to executive compensation as detailed below.

Rise of Realizable/Realized Pay

  • There are different formulations for calculating Realizable/Realized Pay, which makes a comparison between any two companies very difficult
    • Which components of compensation are included in these calculations and how they are valued is the differentiating factor
      • The valuation of stock options is an example of these differences
  • The trend is for Boards to consider the realizable/realized pay numbers for internal purposes, however, whether or not related disclosure is included in the company’s annual proxy is another question
    • Disclosure can help an underperforming company to show that in a year when performance was not there, the realized pay to Named Executive Officers (“NEOs”) was much lower than the number reported in the Summary Compensation Table
    • Consider whether once the disclosure is in the proxy if it will be difficult to take out in subsequent years

Proactive Shareholder Engagement

  • Many companies have included shareholder engagement on executive compensation and related corporate governance issues as a standard annual exercise
    • Even if a company’s Say on Pay vote passed, proactively engaging shareholders can help to keep the positive trend going
  • Members of the Board, especially Compensation Committee members, generally are becoming a more integral part of the shareholder engagement process

The Return of Deferred Compensation Programs?

  • With the economic downturn, there is a restored interest in and use of mandatory deferred compensation programs
    • For example, deferral of annual bonus (in whole or in part) may serve as a retentive tool and, where the obligation is unfunded, helps maintain corporate cash reserve
    • Allows for compensation to be clawed-back by the company if necessary
  • The increase in personal tax rates for the highest earners coupled with the potential loss of deductions and exemptions causes the present value of an executives’ compensation to decrease and the future value of deferred compensation to increase
  • Elective deferred compensation programs are subject to 409A, a provision in the US tax code which governs how and when deferred compensation can be granted
    • This creates a lack of flexibility for company and executive
  • Depending on the appeal, companies may consider elective deferred compensation programs as a retentive tool for senior executives
    • Although not typically considered deferred compensation, stock options are one way that companies may grant deferred compensation and allow the executive to control the timing of the taxation event (provided the stock price is not volatile, stagnant or declining)
      • Future value is increased particularly in circumstances where the executive controls the timing of the taxation event

Recent European Regulations

  • Binding Say on Pay
    • Currently binding in the Netherlands, Norway, Sweden and Denmark.  The implications of failing a binding say on pay vote are not clear, particularly if the vote is retrospective as it is in the US
    • UK is considering a binding Say on Pay vote every three years
  • Caps on Banker Bonuses
    • Starting in 2014 in the EU, “material risk takers” at financial institutions will have bonuses capped at 100% of base salary
      • This has and will likely continue to lead to an increase in base salary, therefore, only serving to provide executives with more guaranteed compensation that is less performance based

Using TSR to Appease Shareholder Advisory Firms

  • Many companies have incorporated total shareholder return (“TSR”) as a performance metric into incentive plans in order to avoid additional ISS/Glass Lewis scrutiny
    • Some companies have started to use TSR as a long-term performance metric for NEOs, while not necessarily using TSR for plan participants below NEO levels (for whom proxy disclosure is not required)

Tension Between Why, How and Who Pays Directors

  • Directors have a fiduciary duty to protect the interests of all shareholders, provide expertise, and serve as advisors to management
  • Directors are often paid using a mix of cash and equity, but what forms those take and how equity vests is often up for debate
    • Time-vested versus performance-vested equity (not common)
    • Restricted stock versus stock options
    • Retainers versus meeting fees
  • Most companies have Share Ownership Guidelines in place for Directors, but the question remains as to what levels of ownership are meaningful to align Director and shareholder interests
  • If Directors are paid based upon the performance of the company, does that invariably change the utility and independence of the directors?  Does this depend on the percentage of compensation that is performance based?
  • There are several recent instances where activist hedge funds have offered director nominees incentive compensation if they are elected to the board and a certain level of performance is achieved
    • Debate as to whether this creates the wrong incentives and allegiances or whether it appropriately frees the directors (if nominates) to make independent decisions in the interests of shareholders
    • Wachtell, Lipton, Rosen & Katz, NYC law firm, wrote memo to clients proposing that companies adopt bylaws prohibiting director nominees from receiving third-party compensation with respect to their nomination
    • ISS and Glass Lewis have not taken a position on this practice
  • Can Directors be independent if they are receiving non-board related fees (such as consulting fees) from the company?
    • Interestingly, as of July 1, 2013, compensation committee members of Nasdaq listed company will not be considered independent if they are receiving non-board related compensation from the company (or any subsidiary)