The Executive Compensation Controversy and What it Means for Equity Plan Managers

Transcription

1 The Executive Compensation Controversy and What it Means for Equity Plan Managers NASPP Silicon Valley Chapter July 11, 2012 Pam Ellis, CEP, Solium Capital Fred Whittlesey, CEP, Compensation Venture Group

2 Agenda A little background Key issues from executive to equity Say-on-pay Pay-for-performance Peer groups What s on the horizon from the SEC for equity pros Clawbacks CEO pay ratio CEO pay-for-performance Why should this matter to you Final thoughts and Q&A NASPP Silicon Valley Chapter - July 11,

3 The Executive Compensation Controversy Brewing since mid-1980s - Disney/Eisner Beginning of Sunday Business Section highest paid lists Focus until recently was dollar amounts (still headlines) Began shift to how and why vs. how much Episodic scandals fueled the fire Michael Ovitz/Disney severance Enron Option backdating Home Depot CEO severance 2008 financial crisis 2012: JP Morgan $2B trading loss, Yahoo! CEO new hire grants NASPP Silicon Valley Chapter - July 11,

4 The Executive Compensation Controversy (continued) SEC continued to increase proxy disclosure requirements Transparency instead of regulation Accounting rule changes option expensing Gives SEC new data for proxy disclosure: fair value Media continues focus and misinterpretation Proxy advisers and institutional shareholders escalate voice and extend their methods ongoing focus on equity Overhang and burn rate Value transfer Poor practices Egregious practices Pay measurement Pay-for-performance measurement Pay vs. peers Peer group construction Voting policy Scoring methods: GRId, high/medium/low concern, letter grade NASPP Silicon Valley Chapter - July 11,

5 The Executive Compensation Controversy (continued) Episodic Congressional focus Stock option deductibility (annual Levin bills) Tax rule changes (280G, 162(m), 409A) TARP Dodd-Frank Occupy movement: CEO pay ratio First year of Say-on-Pay in US in 2011 Resulting litigation citing equity-based pay for executives More of the same in 2012 UK/Europe standards influence US Say-on-Pay in UK soon to be binding 2012 US Presidential Election Year JOBS Act NASPP Silicon Valley Chapter - July 11,

6 Say on Pay Outcomes: Losses Companies Failing SOP Vote Average SOP % Approval 41% 37% Average LTI % Approval 81% 84% Number of Companies with 2 Strikes na 4 High Concern 34% 57% Medium Concern 54% 33% Low Concern 12% 7% NASPP Silicon Valley Chapter - July 11,

7 Voting Examples: Say on Pay, LTI, and ESPP NVidia Say on Pay % Say on Pay % LTI shares % ESPP shares 98% Juniper Networks Say on Pay % Say on Pay % LTI shares % LTI shares % ESPP shares 98% NASPP Silicon Valley Chapter - July 11,

8 Voting Examples: Say on Pay, LTI, and ESPP Infinera Say on Pay % Say on Pay % LTI shares n/a ESPP shares n/a Rigel Pharmaceuticals Say on Pay % Say on Pay % LTI shares (2000 plan) 70% LTI shares (2011 plan) 69% ESPP shares n/a NASPP Silicon Valley Chapter - July 11,

9 Say on Pay What now? High level of scrutiny Unpredictability of voting vs. scores vs. reality Highly correlated with TSR performance Emphasis shifting to focus on areas that might not be meaningful indicators or metrics Limited examples or best practices to follow Increasing influence of ISS/Glass Lewis/GMI Increasing push-back by companies What could happen in Year 3? Let s take a look at a few specific say-on-pay issues NASPP Silicon Valley Chapter - July 11,

10 Dilution Multiple metrics being scrutinized Burn rate (run rate) Full value-to-options conversion Highly sensitive to volatility GICS-based table for allowable rates (ISS) Overhang Value transfer relative to peer group Also highly sensitive to volatility Value based on full term (not expected life) of options by ISS ISS takes costlier of all-options or all-shares assumptions NASPP Silicon Valley Chapter - July 11,

11 Plan and Award Features Being Scrutinized How much Why Evergreen Flexible share counting Liberal share recycling practices Repricing language in Plan Vesting Performance periods Performance goals To whom CEO vs. NEOs Concentration of grants to NEOs NASPP Silicon Valley Chapter - July 11,

12 Pay for Performance Being Assessed ISS gets ahead of SEC in 2012 Performance-based/Non-performance-based pay mix Pay-for-Performance Alignment Qualitative Rigor of goals Multiple measures, all highly sensitive to equity value Year-to-year changes in grant types will affect outcome Timing of grants (December vs. January) will affect outcome Grant features (discretion) affects accounting grant date Note: stock options are not performance-based! NASPP Silicon Valley Chapter - July 11,

13 Peer Groups Likely will be different than your self-constructed proxy peer group ISS s 2012 approach GICS code: four digit two digit Revenue or asset size range (.45x to 2.1x) Market cap (.45x to 2.1x) Will relax revenue range but not market cap range Penalizes smaller high growth companies Special groups for largest companies Dilution peer group is top 25% performers in company s GICS code NASPP Silicon Valley Chapter - July 11,

14 Say on Pay Responses: Process Supplemental filings Push-back on proxy advisers recommendations Charts, graphs, narrative for rationale Performance discussion Employee voting reminders Road shows to meet investors directly Webcasts Direct negotiations with shareholders Pre-proxy Post-proxy NASPP Silicon Valley Chapter - July 11,

15 Say on Pay Responses: Plan and Grant Design Grant changes Performance features on RSUs and stock options Sometimes retroactive Stock ownership guidelines Uniform multiples for GRId scoring (ISS) 5x, 4x, 3x No guidance on what counts Coincident with special retention grants of RSUs (hmm ) Changes in performance measurement for LTI plans Removing subjective measures and discretion Expanded disclosure of thresholds, targets, actual goals Danger of financial measures not correlated with TSR NASPP Silicon Valley Chapter - July 11,

16 What s Next? NASPP Silicon Valley Chapter - July 11,

17 Clawbacks Timing of proposed rules January to July 2012 Recoupment of pay required Upon accounting restatement resulting from material noncompliance No misconduct required Dodd-Frank requires SEC to require securities exchanges Covers current and former executive officers All incentive-based compensation 3-year lookback Clawback amount paid vs. what should have been paid How much of that stock option gain resulted from the overstated portion of profit? NASPP Silicon Valley Chapter - July 11,

18 Clawbacks: Issues Value perception of different types of compensation due to clawback potential Incentive, bonus, option gains, stock can be clawed back (we think) Salary, benefits, pension, SERP cannot be clawed back (we think) Clawback language in agreements Existing grants/agreements adopt policy now, amend later? Future grants/agreements US/non-US Calculation of amounts to be recovered Execution of recovery NASPP Silicon Valley Chapter - July 11,

19 SEC s Pay for Performance Dodd-Frank requirement Timing of proposed rules second half 2012 Disclosure requirement - retrospective Relationship between executive compensation paid and financial performance of the company Many unanswered questions Which executives covered When is compensation paid Performance on which measure(s) Performance over what period NASPP Silicon Valley Chapter - July 11,

20 SEC s Pay for Performance: Issues Equity compensation is the wild card in the compensation paid definition Grant date fair value? Vested value options, RSUs, PSUs? Realized value? Paid definition may affect equity grant design and timing Pay timing vs. performance time period Form of equity Post-vesting holding period to facilitate recoupment NASPP Silicon Valley Chapter - July 11,

21 CEO Pay Ratio Dodd-Frank requirement Timing of proposed rules second half 2012 Another disclosure requirement most recent year Ratio of CEO total compensation to median total compensation of all employees Rife with potential for inequitable measurement Summary Compensation Table methodology Differences in business models Geographic location of operations Outsourced functions Company size NASPP Silicon Valley Chapter - July 11,

22 CEO Pay Ratio: Issues Some Compensation Committees already asking: What s a good ratio? What s our ratio? Enormous calculation challenges: SCT for all employees Equity compensation may be the easy part Voluntary, alternative-method proxy disclosures are already emerging Equity compensation may be the difficult part Proxy advisors consider CEO vs. #2 paid or NEO average Other countries progressing from disclosure to a cap France: Government-controlled companies = 20x NASPP Silicon Valley Chapter - July 11,

23 Equity Value to Participant? Grant Date Fair Value minus Performance Condition Discount minus Ownership Guideline Discount minus Clawback Risk minus Additional Holding Period NASPP Silicon Valley Chapter - July 11,

24 Why Should This Matter to You? NASPP Silicon Valley Chapter - July 11,

25 Why Should This Matter to You Who s dealing with this today on the frontlines Board of Directors/Compensation Committees Compensation consultants Senior executive management Legal counsel Investor relations Proxy consultants But guess who has to deal with this tomorrow behind the scenes YOU, the company s stock plan manager Your employees, who may bear the brunt of changes to equity plans, grant practices, and publicity about your company NASPP Silicon Valley Chapter - July 11,

26 Why Should This Matter to You Key areas to note More work for you Plan complexities that are difficult to administer Shift in equity types granted or grant terms Retroactive modifications Challenges with participant communications and education Changes to grant practices Changes to valuation practices Board member composition (when SOP or CC vote is lost) Budgetary impact More reasons to stay educated NASPP Silicon Valley Chapter - July 11,

27 More Work for You Reports and other information must be PERFECT Keep your stock plan database up to date at all times Audit and enforce controls around your data Focus on Section 16 grants Responses to ISS/Glass Lewis recommendations Supplemental filings Roadshows and webcasts Tight timeframe to generate a rebuttal Alternative calculations Increased requests for information from Board members Be prepared to respond quickly to data requests Expect some late hours and weekends! NASPP Silicon Valley Chapter - July 11,

28 Plan Complexities Modify/update your plan documents Evaluate whether your stock plan recordkeeping software can accommodate these changes If not, what happens then? Look at your current procedures and determine what needs to change to support the new regime A lot of manual work = increased demand on your staffing resources Flaws in initial design may result in numerous downstream fixes NASPP Silicon Valley Chapter - July 11,

29 Equity Types or Terms New types or changing terms can bring complications Vague or subjective goals Recordkeeping capabilities Impact on recipient population Education Modifications to existing awards in an effort to obtain a positive vote Administrative and accounting impact May be a shift in the compensation mix for officer-level employees due to clawback risks May see more cash LTI awards Liability accounting NASPP Silicon Valley Chapter - July 11,

30 Grant Practices Impact to recipient population and grant sizes Dilution issues Harder to get more shares Changes to timing of grant cycles Changes to grant agreements (e.g., clawback language) Changes to holding requirements partly due to clawback risks NASPP Silicon Valley Chapter - July 11,

31 Participant Communications and Education New equity types May be a significant leap in complexity and employee familiarity New performance awards with complicated performance criteria Employee perception this is a takeaway or loss Explain why your company can t do what other companies might be able to Don t forget education to your executives these issues may be new to them as well (as plan participants) Poor communication will negate good intentions NASPP Silicon Valley Chapter - July 11,

32 Valuation Practices Accounting numbers are translated to pay numbers and now compared by proxy advisors, so companies are reevaluating (not real pay, just what they re supposed to publish) Intrinsic value, realized value, and other methods Attacking the accepted methods that we ve been using for awhile what s the right basis? You may be asked for different types of information to support alternative valuations Not within common recordkeeping systems (yet), but you have the fundamental data NASPP Silicon Valley Chapter - July 11,

33 Board Members Shareholders angry over executive compensation may go after the Board members Election to vote on say-on-pay every 1, 2, or 3 years In non-vote years, CC members are the target (Cablevision) Fear of a negative recommendation ( withhold vote) Concerns over media coverage and misinterpretation Higher scrutiny and micromanagement of the company s equity plans Incremental, safe, and supportable decisions Will any of your Board members change as a direct result of these issues? If so, prepare for what usually happens when a Board member leaves or joins NASPP Silicon Valley Chapter - July 11,

34 Budgetary Impact Companies are willing to spend large dollars on getting votes, but very little on participant education, stock plan administration training/staffing, or systems support Make your business case Don t focus on your workload or staffing issues as drivers Translate into issues the Compensation Committee and senior management care about Risk management! Corporate governance! Media attention! NASPP Silicon Valley Chapter - July 11,

35 Final Thoughts Educate yourself Understand your shareholder base, so you can approach them the right way Know what are considered good vs. bad equity grant terms Speak Proxy Advisor fluently Educate your executives Keep in mind the sensitivities we ve just discussed and how they will perceive them NASPP Silicon Valley Chapter - July 11,

36 Final Thoughts (continued) Be careful of relying too heavily on market or peer data Research your Compensation Committee members Other current Board memberships Past Board memberships Frame your concerns in Compensation Committee-speak to be part of the solution Learn their language they have no interest in learning yours NASPP Silicon Valley Chapter - July 11,

37 How to Reach Us Pam Ellis, CEP Solium Capital SOS Aspirations & GEO NECF Get Ready to Rumble: Making Your Equity Plan Data IPO-Ready NASPP Annual Conference Risky Business: 10 Ways to Protect Your Equity Programs Fred Whittlesey, CEP, CCP CECP Compensation Venture Group Blog: payandperformance.blogspot.com see 33 Reasons 27 June 2012 NASPP Annual Conference Value and Valuations: Making Sense of Long-Term Incentive Data 50 Ways to Pay (and Tax) Your Board of Directors NASPP Silicon Valley Chapter - July 11,