No. 510 (April 2005). Total compensation paid to the top five executives added up to more than $250 billion during the 1993 to 2003 time period.

Transcription

1 Nvember 30, 2005 Alan Beller Directr, Divisin f Crpratin Finance US Securities and Exchange Cmmissin 100 F. Street Washingtn, D.C Re: Executive Cmpensatin Disclsure Dear Mr Beller: These cmments are submitted in cntemplatin f an impending SEC rulemaking prpsal regarding enhanced disclsures n executive cmpensatin. They reflect discussins between investrs, cnsultants, directrs and academics in which the undersigned participated at the Internatinal Rundtable n Executive Remuneratin held in Ls Angeles n September 28, The signatries t this letter are ten institutinal investrs frm the United States, Canada and Eurpe. In the aggregate, we manage nearly ne trillin dllars, much f which is invested in the United States. Given the imprtance f the subject matter and the fundamental change in directin f the disclsure scheme that we believe is necessary, we thught it wuld be apprpriate t submit this letter fr yur cnsideratin prir t release f an SEC prpsal. The basis fr ur cncern is illustrated by the fllwing: Crprate assets used t cmpensate the tp five executives at cmpanies grew frm less than five percent t mre than ten percent f aggregate crprate earnings between 1993 and 2003, resulting in a substantial diminutin in cmpany and prtfli values with n assciated strengthening f management incentives; 1 Bards ften fail t bargain at arms length when setting executive pay, and cmpensatin has becme bradly discnnected frm lng-term perfrmance; 2 Sixty cmpanies in the bttm decile f the Russell 3000 lst $769 billin in market value and $475 billin in ecnmic value ver the five years ended in 2004, while paying their tp five executive fficers mre than $12 billin; 3 1 Bebchuk and Grinstein, The Grwth f Executive Pay, Harvard Law and Ecnmics Discussin Paper N. 510 (April 2005). Ttal cmpensatin paid t the tp five executives added up t mre than $250 billin during the 1993 t 2003 time perid. 2 Bebchuk and Fried, Pay withut Perfrmance: The Unfulfilled Prmise f Executive Cmpensatin, Harvard University Press (2004). Current cmpensatin arrangements dilute executives incentives t serve sharehlder interests and can create perverse incentives t destry rather than create lng-term value. 3 Van Clieaf and Kelly, Myths f Executive Cmpensatin: Returning t Basic Principles f Pay fr Perfrmance, The Crprate Gvernance Advisr (September/Octber 2005). Updated data frm the study reprted in that article is cntained in the spreadsheet submitted with this letter. We realize that additinal infrmatin wuld be needed t determine whether the cmpensatin paid at a particular cmpany reflects pay fr perfrmance, and d nt infer that pay is unrelated t perfrmance f the executives at each f the listed cmpanies. Hwever, the pattern within the cmpanies cited indicates that a general discnnect between pay and perfrmance exists.

2 Executive cmpensatin is cited by institutinal investrs as the mst imprtant crprate gvernance issue they face tday. 4 While sharehlders must lk t directrs, particularly cmpensatin cmmittee members, t reestablish pay fr perfrmance, executive cmpensatin disclsures tday (with few exceptins) are wefully inadequate t allw sharehlders t evaluate their directrs and determine hw the cmpany is using cmpensatin t mtivate its mst senir managers. 5 We believe executive cmpensatin decisins are a gd indicatin f the level f independence and business judgment exercised by directrs. Better disclsure is needed t help us evaluate risk t ur capital and ptential return when making investments, as well as t help us make prxy vting decisins. It shuld be emphasized that the type f executive cmpensatin transparency we recmmend is already mandated fr British and Dutch cmpanies. 6 Fr example, bards at UK cmpanies are required t make detailed annual disclsures f executive cmpensatin plans and payments, including: salaries; fees; bnuses; expense allwances; nn-cash benefits; ptin awards; lng-term incentive plans; pay fr perfrmance award criteria; pensin and retirement benefits; terminatin payment prvisins; cmpanies used fr cmparisns; the relative imprtance f perfrmance-based factrs; identity f any cnsultant and details f ther services they have prvided; and amendments t incentive r ptin plans. These UK (and similar Dutch) requirements include frward-lking infrmatin. Financial aspects f the cmpensatin disclsures in the UK are reviewed by the external auditrs. 4 Survey finds executive cmp key issue fr institutinal investrs, Pensins & Investments, April 4, 2005, page 2. The survey was cnducted by Pensins & Investments and Vivient Cnsulting LLC. The tp three issues were executive cmpensatin (34%), directr accuntability (15%) and financial reprting (13%). 5 See Attachment 1 fr an example f hw the current disclsures make it difficult fr sharehlders t evaluate an executive cmpensatin plan and determine hw clsely an executive s cmpensatin is related t his/her perfrmance. 6 The British disclsure requirements fr listed cmpanies are cntained in sectins 234B and 241A and schedule 7A f the Cmpanies Act f 1985 and came int frce n August 1, They als require that the remuneratin reprt be submitted t the sharehlders at the annual meeting fr an advisry vte. The Dutch disclsure and sharehlder apprval requirements, in effect since 2004, are similar in mst respects and are cntained in the Dutch Crprate Gvernance Cde and sectins 135, 383c, 383d and 383e f the Dutch Civil Cde. Dutch executive remuneratin plicies are subject t apprval at each cmpany s annual general meeting f sharehlders. 2

3 The British and Dutch signatries t this letter have experienced imprvement in the quality f dialgue and understanding f executive cmpensatin issues between directrs and sharehlders under the UK and Dutch disclsure systems. We believe ur recmmendatins wuld prduce similar benefits in the US. Recmmendatins We suggest that the SEC cnsider the fllwing disclsure requirements when develping its rulemaking prpsal. Disclsures shuld start frm a principles-based apprach and be aggregated in ne place: Infrmatin n pay and perfrmance shuld be easily btained frm the prxy statement itself, and sharehlders shuld nt require extensive utside research and analysis t develp an pinin. T ften, prxy statements cntain bilerplate statements that sund gd but cnvey little actual infrmatin. T avid bfuscatin, disclsure mandates shuld require cmpliance with the spirit as well as the letter f the law. Disclsure principles shuld ensure that investrs receive a transparent and plain English descriptin f: The cmpensatin plan s apprach t pay fr perfrmance; Determinatin f cmpetitive cmpensatin levels fr each named executive; Lng- and shrt-term incentive cmpensatin plan metrics, targets and measurement perids; Ttal cumulative cmpensatin, including all significant cnsideratin, regardless f when r hw it culd be paid r prvided; Respnsibilities f the cmpensatin cmmittee, bard, management and cnsultants in develping and implementing the plan; and Hw cmpensatin f executives fits within the cmpany s verall cmpensatin practices fr senir emplyees. In rder t avid cntinuing the dilemma we currently face, we suggest that a principlesbased disclsure regime include a mechanism that prvides a fast and efficient enfrcement mechanism fr sharehlders t btain full disclsure when it is nt prvided. Shuld accurate frward-lking cmpensatin disclsures be accrded sme level f prtectin frm federal securities law liability in rder t encurage full disclsure? Disclsures shuld include ttal cmpensatin: We believe that the value f all cmpensatin and benefits including retirement benefits shuld be mnetized and disclsed annually. Bth abslute and year ver year infrmatin shuld be presented. We suggest the fllwing be cnsidered as disclsure requirements: Annual fixed cash cmpensatin (including salary and dividends n restricted stck); Annual bnuses, prfit sharing and ther cash payments; Annual ptin and ther perfrmance-based equity awards; 3

4 The value f cmpensatin fr multi-year incentive prgrams (i.e., under lngterm incentive plans) which is paid, awarded, earned r vested in that year, such as ptins granted and the market value f restricted stck; The targets, time perids and measurement metrics fr bnuses and incentive cmpensatin, as well as any changes made during the year and wh measures the perfrmance; The value f retirement benefits earned (perhaps assuming the executive retired at nrmal retirement age and als assuming the executive left immediately), including any pst-retirement benefits r perks awarded; All ther cmpensatin and cnsideratin, including perks, retentin, terminatin, change in cntrl and transactin-related cmpensatin. 7 Cumulative cmpensatin shuld be shwn: We als believe the cumulative effect f a cmpany s cmpensatin decisins shuld be disclsed. Fr example, the prxy statement culd include a table shwing the cumulative cmpensatin earned by each f the named executive fficers ver the past five years, including the amunt received as a result f ptin exercises and the value f unexercised and unvested ptins. Bth abslute numbers and year ver year cmparisns shuld be presented. The value f equity cmpensatin capable f being earned shuld be shwn under varius scenaris, such as at threshld, target and maximum levels f perfrmance fr all prgrams in effect (even lng-term plans cvering a multi-year perid where the prxy statement cvers nly the first year f the perid). Any hedge, swap r ther transfer f cmpensatin ecnmic value shuld be disclsed. The cntext in which the cmpensatin has been awarded shuld be presented. Fr example, the cmpany s return n invested capital, ttal sharehlder return, market value added (r subtracted) and/r ecnmic prfit (r lss) fr the previus five year perid culd als be included. Disclsure f the percentage f perating prfit represented by executive cmpensatin (e.g., fr each f the preceding five years) wuld assist sharehlders in perfrming a pay fr perfrmance analysis; Sharehlders wuld be able t use this infrmatin t dialgue with cmpanies abut the apprpriate amunt f sharing between investrs and management; and If descriptin f perfrmance metrics in cmpensatin plans presents the ptential fr manipulatin f results due t variatins in the assumptins r calculatin methds used, specific prvisins shuld be established t prtect investrs frm misleading r unreasnable calculatin methdlgies in data used t make pay fr perfrmance cmpensatin disclsures. 7 In rder t deal with variatin in hw cmpanies interpret perquisites fr purpses f required disclsure, the SEC may need t establish a clear and brad definitin fr reprting f perks and cver hw they are t be valued. We als believe that current disclsure materiality threshlds shuld be substantially lwered. 4

5 Pay fr perfrmance infrmatin shuld be fully disclsed: Investrs deserve hnest and clear disclsure f the measures and time perids being used t determine managerial success fr each named executive and hw thse measures link t the firm s business strategy and lng-term success. In rder t fulfill their fiduciary respnsibilities, sharehlders must be able t see what executives are being held accuntable t, and paid t, accmplish n bth a frward-lking and retrspective basis. We believe that cnsideratin shuld als be given t the fllwing specific requirements: Disclsure f the cmpany s cst f capital in the cmpensatin reprt s that investrs can readily tell when a cmpany has actually earned a true ecnmic prfit; Disclsure f the specific frward-lking measures set fr executives, if it can be dne withut hampering the cmpany s cmpetitive psitin. Even if the specific business targets are nt disclsed, investrs shuld be prvided sufficient infrmatin t understand the metrics, targets and measurement perids being used; 8 Cmpanies that use mre than ne perfrmance metric shuld be required t disclse the prprtinal weighting f each ne; Measures shuld be brken dwn int time frames, s that investrs can clearly tell what the ne-year gals and the three-year and lnger gals are - and the difference between the tw. Identificatin f which measures are current peratinal measures and which are lng-term strategic measures 9 wuld help sharehlders determine whether the cmpany is fcused n sustainable perfrmance; If lng-term gals are disclsed, a definitin f lng term shuld be established (e.g., three years r lnger) t avid cnfusin ver peratinal and strategic gals and shw what levels f cmpensatin are tied t bth types f gals? Disclsures shuld include bth financial and extra-financial (e.g., custmer satisfactin, emplyee turnver, ethics cmpliance, envirnmental harm) measures being used t guide management behavir and evaluate their perfrmance; Disclsure f what the CEO and each named executive is being held accuntable fr that is in additin t r different frm the accuntability standards fr his/her direct reprts wuld help sharehlders evaluate the cmpany s cmpensatin planning prcess; The measures being applied t each individual executive fficer rle shuld be required in rder t facilitate investr assessment f the efficiency f a cmpany s cmpensatin plan and rganizatinal structure; and 8 Fr example, cmpanies may be able t retractively describe perfrmance measures withut specifically identifying the targets and d s withut cmprmising their cmpetitive psitin. 9 A review f 2004 prxy statements by The Crprate Library cncluded that 85 percent f cmpanies have n stated multi-year perfrmance targets t encurage executives t create lng-term value, despite mre than half f a cmpany s enterprise value being based n expectatins f future grwth and innvatin. Van Clieaf and Kelly, The New DNA f Crprate Gvernance: Strategic Pay fr Future Value, The Crprate Gvernance Advisr (May/June 2005). 5

6 Pay that can be accelerated by meeting perfrmance targets, but that will be paid at sme pint regardless f perfrmance, shuld be identified as perfrmance-accelerated, rather than perfrmance-based? Cmparables relevant t evaluatin f the cmpensatin plan shuld be disclsed: Disclsure f the cmpanies, measurement time perids and psitins cmprising the peer grup being used fr cmpensatin purpses shuld be mandated. 10 If that grup des nt cmprise the same cmpanies used as cmpetitive peers in the five-year ttal sharehlder return chart, the perfrmance f the cmpensatin peer grup shuld be disclsed. The Cmpensatin Cmmittee shuld be required t explain hw it selected the cmpensatin peer cmpanies and cmparatr psitins, including hw it accunted fr differences in the perfrmance f the cmpanies selected and fr differences in the executive rles 11 between the peer grup and its wn cmpany s executive rles; and Cnsideratin shuld be given t requiring disclsure f cmpensatin infrmatin fr the tw levels f management belw the CEO t prvide a means fr sharehlders t evaluate internal fairness (i.e., internal pay equity) f the cmpensatin plan. Sharehlders culd als use internal pay equity as an indicatr f rganizatinal culture and the bard s independence frm the CEO. The Cmpensatin Cmmittee s narrative shuld be mre meaningful: Investrs deserve t knw hw the Cmpensatin Cmmittee decided t award the cmpensatin it did in light f perfrmance f the cmpany and the individual executive. We believe the Cmpensatin Cmmittee shuld describe the pay philsphy it is applying in its cmpensatin prgrams fr senir executives and shuld be required t explain hw each element f the cmpany s cmpensatin prgrams relates t that philsphy. It shuld als explain hw the frwardlking and retrspective lng-term measures it chse relate t the cmpany s strategic plans. In particular, we believe cnsideratin shuld als be given t the fllwing disclsure requirements: If a cmpany pays perfrmance-based cmpensatin fr years in which the cmpany has nt even earned its cst f capital, the Cmpensatin Cmmittee shuld be required t clearly explain why; 10 A review f 100 cmpany prxies by the cnsulting firm Equilar fund that nly 2 percent prvided the names f peer grup cmpanies used in setting executive cmpensatin. Bstn.cm, March 29, 2005, Benchmarking Inflates CEO s Salaries, Assciated Press, visited Nvember 21, 2005 ( 11 Executives rles can vary substantially between cmparable cmpanies. T illustrate, cnsider Jhnsn & Jhnsn, which is a cmpensatin peer cmpany fr Eli Lilly. The 2003 cash cmpensatin f Jhnsn & Jhnsn s CEO was $ 3.2 millin, while Eli Lilly s was $ 2.1 millin. On the surface it wuld appear that Eli Lilly s CEO was underpaid. Hwever, it might be that the Jhnsn & Jhnsn CEO rle has been determined t be mre cmplex and difficult s the uncalibrated cmpensatin numbers prvide a misleading statement f the amunt f cmpensatin the Eli Lilly CEO is receiving, which may be apprpriate n a cmparable basis. 6

7 The Cmmittee shuld explain hw the cmpensatin plan s lng-term measures are different frm the shrt-term measures it is using, s that sharehlders can understand whether the cmpany is paying executives twice fr the same accmplishments; T assist investrs in determining whether a cmpany s executives have a disincentive t seek payment f dividends, the Cmpensatin Cmmittee shuld be required t disclse whether the ptin and equity cmpnents f the cmpensatin plan are dividend neutral (i.e., awards are adjusted fr dividends); If cmpensatin was awarded that was nt earned accrding t the plan metrics, the Cmpensatin Cmmittee shuld be required t disclse why; Whether the Cmpensatin Cmmittee has reviewed existing plan metrics, targets and perfrmance perids fr adjustment r fr changing circumstances shuld be disclsed, including whether any adjustments were made and why; T identify ptential cnflicts f interest, whether any cmpensatin cnsultant retained by the Cmpensatin Cmmittee has received cmpensatin fr prviding ther services t, r has therwise been retained by, the cmpany shuld be disclsed; Disclsures shuld include whether r nt the cmpany s executives cntracts cntain (and describe) clawback r similar prvisins t recver cmpensatin imprperly paid n the basis f perfrmance criteria that are subsequently restated r revised; and Change in cntrl prvisins embedded in executive cntracts r elsewhere, shuld be identified alng with an explanatin f hw they benefit sharehlders. In summary, we believe that the current US executive cmpensatin disclsure requirements have serius deficiencies that limit the ability f investrs t evaluate the structure and peratin f executive cmpensatin plans. Imprved disclsure arund pay fr perfrmance cncepts wuld help t strengthen crprate gvernance and better psitin cmpanies t succeed ver the lng term in the increasingly cmpetitive wrld markets. We thank yu fr this pprtunity t have input int the executive cmpensatin disclsure rule making prcess. If we can be f any help in further expanding n these recmmendatins, feel free t cntact us. Very truly yurs, Mark Ansn Chief Investment Officer Califrnia Public Emplyees Retirement System Christpher J. Ailman Chief Investment Officer Califrnia State Teachers Retirement System Ian Jnes Head f Respnsible Investment C-perative Insurance Sciety - UK 7

8 Alan G. Hevesi Cmptrller, State f New Yrk New Yrk State Cmmn Retirement Fund William C. Thmpsn, Jr. Cmptrller, City f New Yrk New Yrk City Pensin Funds Claude Lamureux. President and CEO Ontari Teachers' Pensin Plan Meagan Thmas Crprate Gvernance Cunsel RAILPEN Investments (UK) Cleman Stipanvich Executive Directr State Bard f Administratin (SBA) f Flrida Rderick Munsters Chief Investment Officer Stichting Pensienfnds ABP (Netherlands) Clive Edwards Deputy Chief Investment Officer Universities Superannuatin Scheme Ltd (UK) Attachments: (Example f Limitatins in Current Disclsure Regimen) (Matrix Investment Research Hneywell Reprt) (MVC Assciates Internatinal Pay fr Perfrmance Analysis) cc: Paula Dubberly, Assciate Directr, Divisin f Crpratin Finance Betsy Murphy, Chief, Office f Rulemaking, Divisin f Crpratin Finance David Lynn, Chief Cunsel, Divisin f Crpratin Finance 8