Equilar Executive Compensation Summit 2018 Conference Roundup
The 2018 Equilar Executive Compensation Summit took place in San Francisco from June 4—6. Equity Methods was a sponsor and presenter once again. Discussions swirled around topics in executive and equity compensation, from plan design to CEO pay ratio to communication with shareholders and governance groups. Here, we summarize a few of the salient sessions from the summit.
Reevaluating Compensation Disclosure and Shareholder Engagement
Megan Arthur Schilling, Ron Schneider (Donnelley Financial Solutions), and Lyndon Park (Dimensional Fund Advisors)—a group that sees a whole lot of proxy statements at different stages and angles—shared their insights and tips on quality compensation disclosures and shareholder engagement strategies.
First is the importance of clarity in the compensation discussion and analysis (CD&A) section of the proxy. Best practices include substituting out dense text in favor of charts and other visuals that can more effectively convey complex concepts, thoughtfully using headers and bullets to make information easy to find, avoiding redundancy, and writing in plain English. The panel noted examples of companies that had radically shortened their proxy statements by over 30% using these practices, all while making the document clearer and more useful to investors.
Next up? Shareholder engagement. Avoid the trap of only engaging shareholders when there’s a possible problem and you want to sway them. Instead, know shareholder tendencies and keep an ongoing dialog open. Some companies even outline their seasonal cycles of shareholder engagement, feedback gathering, and suggestion implementation as part of their CD&A.
Finally, the panel outlined their expected themes for 2019 in this area. These included:
- Continued focus on pay-for-performance alignment
- Further design enhancements as companies find programs that suit the needs of their business and shareholders
- Continuous rather than ad hoc engagement between companies and shareholders
- Increased scrutiny around goal-setting for performance awards
Employee LTI Choice
This panel—with Kelly Crean (Mercer), Steve Eliseo (Johnson & Johnson), and Drew Steinhoff (Express Scripts)—shifted away from pure executive compensation to discuss employee LTI choice plans. Used by about 10% of S&P 500 firms, these plans give employees the ability to choose whether they receive their LTI grants in the form of options, restricted stock, or some mix of the two.
Johnson & Johnson and Express Scripts are at opposite ends of the experience spectrum—the latter’s choice plan is new, while the former has been running theirs for years—but they share key lessons for companies considering something similar.
For one, implementation initially involves a lot of communication and education effort. Once the plan is in full swing, however, education and communication prove much more straightforward than many might expect.
There are also key design decisions to consider in order to maximize the employee benefit without making the program overly costly or burdensome. For example, what’s the default if no election is made? How many different vehicles or variations can the employee select among? What’s the ratio of options to stock, and is it based on the Black-Scholes value or a fixed ratio? Modeling is key to understanding the tradeoffs and optimizing the decisions.
Finally, the choice program itself can increase employee engagement. Many long-term awards may be pushed to the back of the mind shortly after grant. But by making an active decision, employees engage with their grant upfront in a way that they may not with traditional equity plans.
The Real Value Drivers: Linking Incentives to Shareholders
Check-the-box incentive plans have become all too common in an era of compliance-driven compensation design. In this session, Yvonne Chen, Bob McCormick, and Linda Mills (AIG) focused on goal setting and metric selection for short-term and long-term incentive plans.
Before making any important compensation design decisions, the panelists suggested, first ask what the company strategy is since that should be the foundation of the compensation program. Once that’s thoroughly vetted, the next major decision point is which performance metric or metrics to use. A key nuance is whether to use GAAP or non-GAAP metrics in the incentive program. Among the audience, most said they used non-GAAP metrics given the potential negative impact that one-off events (e.g., accounting standard change or divestiture) can have on incentive payouts.
The panelists also discussed and supported the idea of separate plans for named executive officers (NEOs) and non-NEOs. This was a relief to many, since performance metrics at the NEO level might not be appropriate for employees at lower levels.
The other main topic was goal setting for performance awards and how to ensure sufficient rigor in the process. Linda serves as the Compensation Committee Chair for Navient Corporation, where a major concern is whether a stretch goal is really a stretch. In addition to analysis and insights from the company’s finance or accounting team, she mentioned that analyst reports are another helpful data point in the goal setting process.
A final topic was shareholder outreach and whether it was necessary. The panelists all agreed that outreach is most useful when the plan has unique characteristics or when major changes are implemented. These meetings could also be a good time to gather feedback regarding different aspects of the incentive program (e.g., metrics used or payouts).
Executive Compensation When Things Go Wrong: Clawbacks and Beyond
The modern version of clawbacks began with Sarbanes Oxley 2002 and the SOX 304 provisions. But this regulation really didn’t turn out to be the clawback that regulators were looking for. Dodd-Frank 954 became the alternative, but some regulators think it’s unfair because here the clawback decision is non-discretionary and would apply to all Section 16 officers.
The proposed Dodd-Frank 956, which applies to banks with more than $50 billion in assets, has a good chance to pass. Dodd-Frank 956 says that for executives and significant risk-takers, banks could claw back variable incentives for up to seven years after vesting. This proposed regulation is similar to the European Union’s CRD IV rules which have been finalized and state that “material risk takers” can have their compensation clawed back.
Russ presented the case of Wells Fargo’s recent restatement, suggesting this was an event that changed a lot of things surrounding clawbacks. Boards can no longer rely on a “wait and see” approach to the implementation of clawbacks in the compensation packages of their executives. Even if Dodd-Frank regulation is unlikely to be implemented soon, boards need to do the right thing and put in place sensible clawback provisions on their own. Additionally, while up to this point there’s been little scrutiny of the quality of different kinds of clawbacks, that will likely evolve over time.
Around 96% of companies disclose some form of a clawback policy. One company has an interesting provision that is not triggered by misconduct, but instead by an act of omission that constituted reputational harm. This suggests a slippery slope around the question of how to measure reputational harm.
Eric discussed common terms found in clawbacks. The most common lookback is three years, with one year being the second most common. The balance to strike is between providing the board a reasonable timeframe for clawing back compensation versus executives feeling like the terms are fair. Whether the committee should have the discretion to ignore misconduct is another important question.
The panel discussed the usual issues that companies should think through when considering implementing clawbacks in their compensation plans, including changes potentially required to expand compensation committee authority. Triggers based on amorphous concepts like reputational harm may be less palatable to executives, but industry practices may be headed that way regardless.
The CEO Pay Ratio: A Review of Results from the 2018 Proxy Season
After years of preparation and anticipation, during the 2018 proxy season a large number of US companies disclosed their CEO pay ratio for the first time. Nathan O’Connor, Amy Wood, and Courtney Yu (Equilar) provided an overview of the first round of 1,800 pay ratio filings made through mid-May 2018.
After sharing summary statistics on the results of the filings, the group cautioned the audience against misinterpretation, noting that simple statistics don’t capture the specific company circumstances at play. While the maximum ratio disclosed so far is 5,908 and the minimum is 0, pay ratios vary by sector, market cap, revenue, and geographic region. Not surprisingly, larger companies tend to have higher pay ratios and the highest pay ratios tend to be seen in the consumer goods and services sectors.
In calculating their pay ratio, companies must select a date for determining their employee population. Most companies selected a determination date close to either end of the three-month window preceding their fiscal year-end. Another interesting pattern was that while only a small percentage of companies gave supplemental disclosures, most of those were related to the impact of one-time awards on the pay ratio.
In terms of key lessons, the first wave of disclosures has gone fairly smoothly. Companies have had few highly-publicized problems with their employees stemming from the disclosures. In general, the media has not run many stories related to pay ratio results. This could be due to the long runway that companies had to form their disclosures, enabling them to get out in front of the results. It could also be that, thanks to sites like Glassdoor and Salary.com, companies’ pay practices were already somewhat known.
The panel concluded by discussing other key pay ratio experiences such as the prevalence of various CACM definitions, the usefulness of the data, the length and location of the typical disclosures, and the general avoidance of statistical sampling.
For more resources and information on CEO pay ratio, visit our Hot Topics page on the subject.