10 Trends We’re Watching and the Mild-to-Wild Ways They Could Play Out in 2023
Every Q1, we put on our soothsayer hats and form predictions for the future. Sometimes we focus on a specific area as we did in 2022 on long-term incentive strategies. Other times, we look further out into the future or more broadly across the landscape.
This year, amid so many regulatory and macroeconomic tailwinds, we’re going to look at 10 trends and forge predictions for how they’ll unfold in the next one to three years. As we know, some trends start out heavy and fizzle into insignificance, whereas others continue to gain momentum and ultimately reshape the entire landscape of practices. With that in mind, we’ll introduce each topic, discuss what to focus on in 2023, then look past 2023 to understand the mild-to-wild ways each trend could reshape equity compensation, incentive design, or financial reporting.
1. Pay vs. Performance Proxy Disclosure
Predictions for 2023
This year is about execution, convergence in methodology, alignment of best practices, and the broader group of stakeholders (investors, the media, and the SEC) coming up to speed.
The more extreme disclosures will get the headlines and may lead to over-generalizing that executive pay does or does not work well. Meanwhile, ISS will explore whether and how to incorporate PvP into its quantitative tests, such as by building a black-box model that grades the statistical relationship between changes in pay and changes in performance.
We’re coordinating with many of our clients to build out dashboards of analytics that illustrate fluxes and attribution analysis of key CAP drivers. Many compensation committees have expressed an interest in obtaining additional insight into variance drivers and intra-year monitoring.
A mild outcome for PvP is that it becomes a compliance matter like CEO pay ratio. It will still be the most complex series of calculations in the proxy, but its reach and relevance will be subdued. We’re flipping a coin on this one.
A wild outcome is that PvP becomes a central measure of analysis for investors and the media—in a sense, replacing the role that the summary compensation table (SCT) has today. The reason CEO pay ratio became little more than a compliance exercise is because it didn’t yield any new information beyond what’s already in the SCT and what you could glean from a free Glassdoor account.
PvP is different. As critical as we’ve been about PvP’s fair value-based framework, investors and the media may embrace it. More frequent media mentions could give PvP greater salience in investor, proxy advisor, and even compensation committee discussions of executive compensation. If ISS grades PvP relationships, this could amplify the trend.
2. Clawback Disclosure
Clawbacks have also been a hot topic among our clients. The SEC proposed a clawback rule stemming from the Dodd-Frank Act back in 2015, then finally published an expanded version of the proposal on October 26, 2022. On February 22, 2023, both the Nasdaq and NYSE issued their proposed rules, which are subject to SEC approval before starting a 60-day clock by which companies must be in compliance.
Predictions for 2023
With implementation around the corner, the top question companies and their legal counsels must tackle is how the policies should interact with any existing policies. We expect to see a segmented model in which three frameworks must all interact:
- Sarbanes-Oxley (SOX) clawbacks covering at-fault financial restatements
- Dodd-Frank clawbacks covering not-for-fault financial restatements of both the “Big R” and more prevalent “little r” varieties, thus having much broader reach than a SOX clawback
- Voluntary clawbacks that typically provide an even broader reach than a Dodd-Frank clawback, but afford the compensation committee considerable discretion in enforcement and measurement
This is a solvable problem, but will require good agreement drafting and careful education so the board understands how the moving parts work together. We encourage companies to perform the equivalent of cybersecurity tabletop exercises to plan who will do what in an actual enforcement situation.
We’ve also discussed the complexities of determining the appropriate clawback amount, if any, in the context of total shareholder return (TSR) awards. The SEC spends over a page in the final rule talking about an event study and the measurement complexity, then ends with the point that registrants can choose their method as long as it’s reasonable. We think an event study will be the method of choice given that it’s the de facto standard in litigation, but unfortunately, any model will be noisy when applied to “little r” restatements.
We hate to say it, but we don’t anticipate any truly mild outcomes. Hundreds of restatements occur annually. These must trigger a clawback of performance-based compensation. The best we’re hoping for is that boards can consistently and comprehensively enforce these new provisions without litigation or violating the listing standard rules.
That said, we also don’t expect too many wild outcomes. Clawback agreement language will converge. The principal challenges will be enforcement, given the breadth of employees affected. A wild outcome is one where the board fails to enforce the clawback provision and receives a notice of ineffectiveness from its listing exchange, or where a shareholder suit alleges the enforcement failed to meet the standard of care.
Enforcement breakdowns can occur for many reasons. A common one is that the rule applies to former employees and has global reach, suggesting there will be many individuals from whom it will be tough to obtain any recovered funds. A TSR measurement problem also could end in litigation if the company concludes a clawback is unnecessary and shareholders allege the analysis wasn’t up to snuff.
3. Human Capital Management (HCM) Disclosure
On August 26, 2020, the Clayton SEC released a rule titled “Modernization of Regulation S-K Items 101, 103, and 105.” Among other things, this revamped the human capital disclosure required in Item 101(c). We covered this in a blog series, a report on the year one disclosures, and a webcast.
Predictions for 2023
The 2020 rule is principles-based by requiring disclosure of a company’s “human capital resources to the extent such disclosures would be material to an understanding of the organization’s business.” The SEC’s two Democratic commissioners at that time wanted a rule-based approach, and in 2021, Chair Gensler gave a talk signaling an intent to revise the requirement in exactly that way.
Revisions to the HCM disclosure are on the SEC’s 2023 agenda, and these could be anything. They may require a handful of simple ratios or an expansive set of disclosures. Another question is comparability and measurement. In a rules-based world, the rules must explain how to perform calculations so that investors can trust that company A’s calculation is the same as company B’s.
There are three ways to think about mild outcomes:
- A simple, low-volume number of required calculations. The SEC starts slowly by requiring only a few basic metrics. Examples may include annual turnover, dollars of training per employee, and gender and ethnicity statistics (overall or in the C-suite)
- Flexibility in calculation methodology. A pivotal question is whether to impose a specific calculation framework on all companies or let them pick a reasonable methodology. The latter is much more accommodating to companies with different facts and circumstances, but may reduce comparability. In general, the more flexibility companies have to develop their own calculation methodologies, the milder the outcome
- Lengthy timing runway. Whatever the rules are, the SEC gives adequate time to prepare, develop processes, establish controls, etc.
It’s possible we could get one of these mild outcomes, but hard to imagine the SEC will give us all three.
Wild outcomes are the inverse: sprawling calculations, a rigid methodology, and a short implementation runway. Let’s think about what this could mean.
First, there’s a bigger problem we need to consider: More and more corporate reporting is non-financial, which is not subject to external audit. At some point, some company will generate large shareholder losses, prompting lawsuits alleging that investment decisions were linked to disclosures of non-financial data like HCM, climate performance, or governance.
Mandatory HCM disclosures could get wild as they become more complex and require more tracking, analytics, and internal review to ensure they’re accurate and in line with SEC rules.
Another potential wild outcome is the interplay between a disclosure like this and the compensation committee’s expanding charter, which in many cases includes oversight of human capital management. As HCM disclosures come online, there will be more data used to evaluate the board’s effectiveness and which individual board members will need to understand.
4. Rule 10b5-1 Revisions
On December 14, 2022, the SEC adopted amendments to modernize Rule 10b5-1 and related disclosure required under Regulation S-K. These amendments became effective on February 27, 2023. The revisions are tamer than those in the exposure draft, but nonetheless substantially clip the wings of how 10b5-1 plans will be used in practice.
Revisions include a lengthier cooling-off period, disallowance of overlapping plans, a limit to one single-trade plan per 12-month period, and various additional disclosures.
The SEC’s amendment also added a new Item 402(x) to Regulation S-K requiring a tabular disclosure of equity grants made within four days prior to the release of material nonpublic information (MNPI) or one day after.
Predictions for 2023
During our annual state of the union webcast, a large majority of the audience indicated they planned to continue using 10b5-1 programs and simply make modifications to comply with the new rule. The benefits of these programs outweigh their costs even though the costs are now higher and the benefits are lower. We don’t anticipate any wholesale revisions other than these.
The Item 402(x) disclosure may be the sleeper. This table will require new processes to correctly compile its contents. Any adverse findings in the table could invite additional inquiry from regulators, investors, or the media. Fortunately, this won’t be effective in applicable statements (for most, the proxy) until the first filing covering the first full fiscal period that begins on or after April 1, 2023. In any event, we expect the majority of companies whose typical grant timing falls within a now-covered window to shift their practices such that grants do not typically occur within such windows.
This SEC is extremely focused on the opportunistic use of information. Their strategies include both prevention and enforcement. The Rule 10b5-1 revisions will primarily work to prevent abuses. The cost of implementing these programs will go up and they’ll make it harder for executives to capture liquidity. But in doing so, it’ll also be harder for executives to get in trouble.
On March 8, 2023, the SEC charged the executive chairman of a healthcare company with insider trading, and the Department of Justice simultaneously announced criminal charges. This executive sold shares within days of entering into a 10b5-1, which would not be possible under the new mandatory 90-day cooling-off period. In this regard, the new rules are likely to reduce the frequency of wild outcomes.
Time will pass and SEC/political administrations will change. The net effect of these Rule 10b5-1 revisions will be to make it harder for executives to capture liquidity and diversify their wealth. As a result, we wouldn’t be surprised if further out into the future there are new creative schemes for solving these problems. If so, we’ll need to make sure they don’t violate then-current hedging policies or other insider trading rules.
But the only truly wild outcomes we anticipate are startling results in the Item 402(x) disclosure due to companies accidentally timing equity grants to occur in close proximity of MNPI releases. This could also trigger a SAB 120 spring-loading problem. So far, our experience is that spring-loading is rare. But it can occur due to inadvertent sequences of events—and if it does occur, the harms could be substantial.
5. FASB Focus on Human Capital
The Financial Accounting Standards Board (FASB) has mainly focused on its namesake process and on simplification. Now the FASB is at a crossroads on how much to influence non-financial reporting in the ESG space and whether to cede ground to organizations like the Sustainability Accounting Standards Board (SASB).
For now, the FASB has two topics on deck that touch on human capital:
Both will result in additional disclosure and transparency into human capital costs where equity compensation tends to drive much of the complexity.
Predictions for 2023
We expect a final accounting standards update (ASU) for both of these topics in 2023, with segment reporting in the next two to four months. Neither is likely to result in entirely new measurement approaches to stock-based compensation since the focus is on the granularity of information disclosed.
A mild outcome is that each FASB update requires few to no process revisions. For example, we already maintain detailed calculations for our financial reporting clients. They wouldn’t face any incremental challenges in displaying information differently.
Outside of stock-based compensation, the segment reporting ASU will have a wild effect by inducing many companies to share much more information about their operating segments that they had intentionally kept private.
With respect to stock-based compensation, companies that perform pool-level calculations will have a problem now that they need to disclose expense information in a disaggregated capacity across P&L line items and operating segments. Many companies track their employee stock purchase plans (ESPPs) at a pool level.
6. Board and Executive Officer Oversight
On January 26, 2023, the Court of Chancery of the State of Delaware ruled against David Fairhurst, the former head of human resources at McDonalds. It was a case that will rewrite how we think about officer liability. In short, the court extended the Caremark framework, which vests liability in directors, to apply just as much to corporate officers.
Predictions for 2023
Pending any appeals, which we doubt will be successful, the Fairhurst decision means that corporate officers have personal liability for their acts of omission and commission in areas over which they’re reasonably expected to exercise oversight. For instance, a chief people officer is expected to exercise oversight of fair pay practices but not cyber risks.
There’s nothing mild about the court’s decision because it resolves an ambiguity in case law that existed since the Caremark decision was handed down in 1996. Caremark established that directors have a responsibility of oversight, but there was never a clear line in the sand concerning the obligation that corporate officers have. Now there is.
We don’t expect this new precedent to generate many frivolous cases, though. The Fairhurst case concerned severe breakdowns in oversight, including ones promulgated by the HR chief himself. The court’s opinion doesn’t suggest they’re changing the scope of what constitutes reasonable oversight. Instead, they’re clarifying that officers are personally responsible for discharging their oversight duties.
The scope and complexity of matters under the purview of the chief people officer are expanding at light speed. Pay transparency laws, wage and hour laws, equal pay for substantially similar work (pay equity) rules, and more make the compliance side of a people function more complex than ever before.
Since corporate officers are at greater risk of being named for their failure to exercise oversight, companies—which will also be named—will likely need to indemnify and defend their officers who are named personally. This will trigger the need for internal investigations to sort out where fault actually lies and how to think about blame apportionment (if any). It also will add yet another nuance to the compensation committee’s job.
7. Universal Proxy
In 2021, the SEC released Rule 14a-19, setting in motion the “universal proxy card.” Beginning with proxy votes occurring after August 31, 2022, SEC registrants must collaborate with all dissidents contesting the proposed slate of directors to provide shareholders with a single universal proxy card. This removes the “all or none” nature of historical contested elections and allows shareholders to pick and choose across the nominees from both the company and the dissident(s).
Predictions for 2023
We think universal proxy is a potential game-changer—but not in 2023. Shareholders aren’t looking to go nuclear and shake boards up for the sake of it. Already, there have been a few contested elections. A notable one was Land and Building’s contesting of Aimco’s proposed directors. L&B prevailed in replacing one director with its own candidate.
We expect to see more of this in 2023, but primarily in cases involving severe underperformance. Successful dissents will likely end with the replacement of one or two board members, not the entire crew. The reason we think universal proxy is game-changing is because of its intermediate-term effect on boards and how this will reshape the way boards and management teams interact.
A mild outcome in the years ahead is one in which individual directors of severely underperforming companies periodically fail to win reelection. Relatively few companies experience actual upheaval, but it can serve as a deterrent to the benefit of governance and board effectiveness.
A wild outcome is one in which directors frequently lose their reelection bids, whether for good reasons or trivial ones. This would have far-reaching ripple effects, especially if the dissident’s choice of replacement brings acrimony and gridlock to committee meetings.
In some respects, the last 10 years have been a golden age for compensation committees—reasonable say on pay results, rising stock prices, low equity proposal rejection rates, etc. Even so, the number of annual committee meetings is steadily rising. So are the lead times to socialize information. An influx of dissident members could easily upend the status quo’s delicate equilibrium.
8. Share Pool Management: Playing Offense or Defense
This could be the year when share pool management returns to the forefront. For many years, we’ve seen rising share prices and therefore relatively simple share pool management. Many of today’s executive compensation professionals weren’t in their roles in 2008 when this problem last surfaced. And, as the title of this section suggests, not everyone will have a share pool problem that puts them in the defensive.
Predictions for 2023
When we first began thinking about share pools, we assumed 2023 would be a year involving extreme defensive action to shore up share pools and avoid catastrophes where the pool can’t absorb the granting required. But lately we’ve heard from companies in mature industries that are now finding themselves playing offense.
Therefore, our prediction is that the winners will be the companies that maintain rigorous share pool forecasting and planning so they can take the right balance of offensive and defensive action.
Defensive maneuvers include revising long-term incentive program (LTIP) eligibility, adjusting quantum, and changing a portion of the LTIP to be cash-settled. Some companies are reducing LTIP eligibility while adding features to their ESPPs to balance the take with a give. Offensive maneuvers include revisiting equity buyout methodologies, proactively rolling out more attractive ESPPs, and evaluating longer-term moonshot or similar equity award designs.
This topic will largely be driven by market behavior, whether the economy reaches a soft or hard landing, and how the effects play out across sectors. Given the uncertainty, we suggest considering the wild outcomes that could transpire.
Potentially wild scenarios include the following:
- If the economy tailspins, share pools will run out much quicker than anticipated. To preserve long-term incentive granting, solutions could include partial grants, grant promises, cash-settled awards, and equity modifications. These may need to be implemented with little or no notice
- Share pool requests may also need to be accelerated. While these can be effectively planned, continuously declining prices can create a vicious cycle of repeatedly trying to catch a falling knife
- It’s also unclear whether an economic tailspin would accompany a loosening talent market. Many experts predict the latter will remain tight given the wave of retirements, reduced immigration, and other factors constricting supply. If equity prices are depressed and talent remains tight, we could expect to see more equity modification activity as we did in 2008
- If the effects of economic malaise are unevenly felt across sectors, we could see entirely different actors making offensive moves to accumulate talent. The saying that every company will become a tech company suggests talent may be more mobile across sectors than we’ve traditionally assumed it to be. We could see companies in mature and traditional industries becoming much more creative in how they use equity outside the C-suite
- Finally, we may see plumbing initiatives that revisit retirement eligibility provisions, share recycling provisions, and the use or disuse of stock options. We traditionally focus on share burn, but there’s also share leakage—inefficiencies in the program design that could be patched to conserve more shares
9. Equity Award Modifications
Modifications climb during periods of volatility and uncertainty. In 2020, many companies modified their LTIP targets to adjust for the unexpected shock from Covid-19. In 2008, option exchange programs sprang up to restore incentives and bolster retention.
Predictions for 2023
We expect to see diverse modification activity this year, recognizing however that today’s governance climate is much different from 2008. There are three main classes of modifications we’re predicting:
- Favorable treatment in reductions in force and buyout offers. This includes extending the post-termination exercise window on options and accelerating all or some vesting of awards that would otherwise forfeit
- Option exchange programs or adjustment of performance goals. These can be particularly controversial when directed toward the named executive officers (NEOs) in the proxy. However, many earlier-stage companies won’t care about proxy advisor controversy and are likely to explore these options amid a crumbling share pool and broken equity incentives
- Automatic modifications from an ESPP reset or rollover. Many companies are going through ESPP reset and rollover events for the first time. These can give rise to large financial statement charges and require robust tracking and calculations
Mild outcomes are one-off events that don’t affect the NEOs. We’re already seeing these happen and expect them to continue as long as the markets remain tenuous.
Wilder outcomes include bold modifications that invoke shareholder ire. For early-stage technology and biotechnology companies that issue options, we might see a resurgence of exchange programs.
The percentage of large caps and even technology companies issuing options is significantly less than it was back in 2008. The most common equity stack is an equal weighting of performance-based and time-based RSUs. We might see efforts to reset performance goals as we did during 2020, but it’s hard to imagine any large-scale trend of that nature.
Another possibility is that companies stretch out performance goals to make payouts less sensitive to performance. This could turn wild if it ends up worsening pay-for-performance sensitivity and functionally turn the entire LTIP into a glorified RSU grant. Although this could work in the short term, eventually it could invite problems with proxy advisors—and may even prompt them to strengthen their focus on relative performance.
10. Award Design Trends
Award designs remained relatively stable in 2022. TSR continued to be the most prevalent metric, with 72% of S&P 500 companies using it in some capacity. Earnings and return metrics ranked second and third, respectively. Since these are usually specified on an absolute basis, many companies intentionally built macroeconomic uncertainty into their performance goals. ESG continued to find its way into annual plans but remains rare among LTIPs (4% in 2022 up from 3% in 2021).
Predictions for 2023
We don’t expect to see major changes in 2023. Interest rates were rising and stocks were falling as calendar year companies began planning their 2022 grants, which put the brakes on wholesale changes.
In the intermediate term, we expect a handful of milder changes to affect the face of equity compensation:
- Relative TSR will grow from 70% prevalence to 80%. Having some relative focus in the LTIP provides another type of insulation against uncertainty and conforms to how proxy advisors assess performance
- Ongoing pressure will bring TSR fair value premiums closer to the face value of the stock. Market volatility caused the average TSR premium on a standard 0% to 200% payout design to approach 140%, which can wreak havoc on reported proxy values or realizable pay (depending on how shares are calibrated). We expect to see more pressure to bring these fair values down through creative award design strategies
- Performance goal-setting will favor safety while proxy advisors renew their full-court press on goal rigor. While in theory this tension is healthy, the problem is that proxy advisors lack good tools for evaluating goal rigor
- ESG utilization will crawl forward, but very gradually and only when the ESG metric has an existential relationship with the company’s strategy. This is why so many utility companies already have ESG metrics and why other companies embrace the criticality of many ESG metrics but struggle to pick one for their LTIP
- ESPPs become more prevalent and lucrative. ESPP share requests are rarely denied and can be key retention and talent acquisition drivers
We aren’t predicting a wholesale shift to any of these strategies in the next two or three years, but we do think some will take hold either due to bold corporate strategy or external pressure. Scenarios include:
- Longer performance periods. Many European institutional investors, and some domestic funds, have been pushing for performance periods of five years or longer
- Stretch relative performance targets. On relative percentile ranking designs, proxy advisors have been pushing to set target at the 60th percentile, stretch at the 85th percentile, and threshold at the 35th percentile. This has yet to catch on aside from a handful of large caps, but it could be when the proxy advisors turn up the heat
- Mini moonshot grants. Whereas Tesla-style moonshot grants became popular during 2021, we’re seeing some companies issuing much smaller price-hurdle awards to drive retention and galvanize key leaders. We call these “mini moonshots” because their quantum is much lower—something like one times the annual long-term incentive
- Reduced equity usage. The combined effect of dwindling share pools and greater investor focus on dilution could reduce overall reliance on equity compensation. While we don’t think this is likely, it’s a wild outcome that could have very negative effects on retention and talent acquisition were it to take hold
- Business unit equity. We’re working with dozens of large companies that are exploring internal incubation units akin to Alphabet’s X. The basic premise is to jumpstart innovation internally, which could be much cheaper than buying startups at extreme multiples. This works best when the parent entity can deliver equity that’s linked to the value creation of the internal startup
There you have it: 10 topics and how we expect them to unfold in 2023 and beyond. We’ll monitor in the months (and years) ahead to see how well these thoughts stand up to time. Regardless of how the macroeconomic and shareholder governance trends unfold, we cannot stress enough the importance of data-driven modeling and analytics.
Many corporate teams have encountered turnover and lost institutional knowledge. Yet the proxy is becoming more quantitative, non-financial reporting is abounding, and external pressures are higher than ever with an uptick in regulation and game-changers like the universal proxy card.
In closing, here are 10 processes we suggest you study and consider enhancing if they’re stale, rigid, or overly basic in their functionality.
- Processes for monitoring granting activity in relation to MNPI now that SAB 120 is live and Item 402(x) is about to be
- Stock-based compensation accounting processes with an eye to agility, controls, and management reporting in light of intensifying forecasting needs by senior management, upcoming FASB revisions, and award design changes
- ESPP tracking processes, which are a subset of the prior item, but also include a host of different calculations (like tracking IRS limits and payroll deductions) all in one place
- Allocation of stock-based compensation to segments, cost centers, business units, and other categories—both in response to the FASB’s push for more granularity and senior management’s interest in burdening these groups with the full scope of costs they incur
- Modeling processes that ensure share pools can be flexed across future scenarios to uncover potential problems should markets take a turn for the worse
- Pay equity processes in light of the great resignation and other upheaval in the talent markets, in addition to the compensation committee’s thirst for plain-English clarity
- Processes for effectuating a clawback, especially since no company expects a restatement yet must take swift action without any prior experience if one happens
- PvP calculation processes with a focus on enhanced analytics so that you can unpack variance drivers and equip your compensation committee with better insight into how and why numbers have changed
- Realizable pay and unvested equity modeling tools to monitor and preemptively flag retention risks
- Human capital analytics and metrics in anticipation of SEC revisions and the possibility that the SASB or FASB may follow suit with additional regulations
Questions? Feedback? Please reach out. I’m happy to continue the conversation.
 Why doesn’t this term sound like the name of an 80s rock band? Because we didn’t come up with it this time. A client did.