A recent headline from WorldatWork indicates the gap between CEO and CFO pay is growing farther apart. The study conducted by BDO USA, LLP indicates that CFOs average 40% of CEO pay at 600 public companies included in the study. One reason offered for the increased disparity is due to CEO pay being more commonly tied to the increase in the company’s equity, which for most public companies, increased substantially in 2010 and 2011.
While CEO’s have historically been paid at levels higher than the rest of the executive team, this recent trend of an increased gap could lead to problems. Shareholders may assume that the change in the CEO – CFO pay comparison could be a reflection of how the Compensation Committee values the relative roles of risk-taker vs. risk-controller. Let’s hope not. That led to some serious problems in the past. It is more likely that the bigger recent gap is due to the 2010 and 2011 run up in stock prices and the CEO’s larger percentage of compensation tied to stock price gains. Should the mix be so different for the two positions? A return to a more equitable internal pay structure will help avoid potential perceptions among shareholders that CFOs are not valued as much as they have been in the past.
With slowly improving economic indicators, organizations are reviewing current compensation practices. In addition to the scrutiny on executive compensation as a result of Dodd-Frank, this renewed focus on executive pay will require organizations to focus on their philosophy and implement equitable compensation plans. Compensation Committees may want to look at how relative compensation has changed over time and consider ways of optimizing compensation mix to stabilize the fluctuation in the comparisons.
In our Firm’s work with client executive teams, we have historically measured the internal pay equity of senior executives measured as a percentage of the CEO’s pay. We have significant, historically viable data showing the relative pay for all executives on the senior team as related to that of the CEO. Two critically important objectives of any company’s compensation philosophy should be to target external competitiveness and be internally equitable.
If you would like a review of your company’s current compensation practices measured against market, industry and custom peer groups, please give us a call (919-644-6962) or visit us at http://matthewsyoung.com.
The Dodd-Frank Act, signed into law in July 2010 by President Obama, shines a bright light on many issues related to Executive Compensation and Corporate Governance. Specifically, one section (952) requires the SEC to adopt rules regarding Compensation Committee members’ independence and suggests a specific list of factors to be identified that will govern the Committee’s advisors. To quote chapter and verse, Section 952 – The Commission is directed to establish competitively neutral independence factors for all who are retained to advise compensation committees
First, a couple of definitions according to Webster’s dictionary:
Independent – not subject to control by others, not requiring or relying on something else, not looking to others for one’s opinions or for guidance in conduct
Neutral – having no personal preference, not supporting or favoring either side…
Personally, I don’t know how “independence” can be anything other than “neutral”…this seems a little redundant, but I digress.
The SEC is required to adopt the new rules by July of 2011 (within one year of the law being signed). The rules will require that public companies disclose in their proxy when they hire an outside compensation consultant, whether potential conflicts of interest exist (in other words – if the consultant has a personal preference or is potentially subject to control by others) and what the Committee has done to address the potential conflict. This will obviously influence Committee behavior in hiring such advisors by encouraging them to avoid any potential conflicts or breaches of neutrality and independence. In only the most extreme cases, could a Committee justify hiring an advisor that violates the independence test without public scrutiny and shareholder unrest.
Much like Sarbanes-Oxley’s requirements of independence and neutrality with regard to Audit Committee advisors, these new rules on corporate governance seem to fall into the category of “doing the right thing”. Some consulting activities that seem to contradict this characteristic would be selling products to companies whom you advise, simultaneously working for management on other projects without full disclosure and prior approval of the Committee or an engagement advising companies for fees where the consulting principals have a significant ownership position (i.e. shareholder).
At Matthews-Young, we have always subscribed to the higher ideal of “doing the right thing”. We require that we be hired and report directly to the Compensation Committee when we are engaged for Executive Compensation work. We have no sources of revenue other than being paid for our time and knowledgeable, expert advice without “supporting or favoring either side”.
If we can assist you with improving your company’s governance and committee effectiveness please give us a call at 919-644-6962 or ask us to contact you at http://matthewsyoung.com/contact.htm.
The Dodd-Frank Act, signed into law in July 2010 by President Obama, requires publicly traded companies to disclose the following additional information in their proxy.
Pay for Performance
A disclosure regarding the relationship between a company’s financial performance, including changes in shareholder return and the executive compensation actually paid.
Comparison of Compensation
A comparison of the dollar amount of the median of annual total compensation of all employees (excluding the CEO) and the total annual compensation of the CEO, with a ratio of CEO total compensation to the median total of all employees. Total Compensation is expected to be defined according to the SEC rules for calculating total compensation for named executive officers in the Summary Compensation Table in the current proxy disclosure rules, but we will have to wait for the SEC rules to be certain.
The final rules regarding these disclosures is the responsibility of the SEC but the Agency has no deadline for publishing the new rules. A recent comment from SEC Chairwoman Mary Schapiro indicated that the final rules would not likely be in place for the 2011 proxy season.
One challenge (and burden) for all companies will be the requirement to calculate the total compensation of each employee under the same rules as named executives in the proxy to then be able to calculate the median value. This will require computing the value of equity awards, bonuses, perquisites, changes in the value of pension plans for all employees (full and part-time) and a conversion to US dollars of foreign subsidiaries employees’ compensation. The Act does not limit these disclosures to the proxy statement but includes disclosure in a number of SEC filings (i.e. registration statements and quarterly and annual financial statements).
It’s obvious that this new disclosure provision of the Act will require an inordinate amount of time and effort to comply. Furthermore, it will also likely require a good bit of narrative for companies to explain their methodology and computation of all employees total compensation, especially when the ratio comparing CEO’s pay to the median of all employees is seen to be excessive or out of line with peers.
What will this new disclosure reveal about a company’s compensation strategy and philosophy? Will companies change their compensation strategy as a result of this disclosure? Will it influence the type of compensation offered in order to reduce or minimize the total compensation value calculation? What does the proposed ratio really tell us about the value of a CEO’s compensation? These are but a few of the questions that come to mind in light of the “unintended consequences” of the new Act.
We are working with clients on methods for collecting necessary data for disclosure and preparing draft proxy statements for Committee review. We recommend companies begin to prepare early for these new disclosure rules that will become required once the SEC publishes the final rules.
Say on Pay is not a new concept to executive compensation but since it’s now law (Dodd-Frank Act), a quick look at history might be useful.
Shareholder votes on executive compensation practices initially surfaced in the UK as early as 1999.
The first negative vote on executive compensation occurred in 2003, when GlaxoSmithKline shareholders voted against the report of compensation paid to executives.
In 2007, in the U.S. there were about 50 companies that had shareholder resolutions calling for an advisory vote on executive compensation.
In the 2007 – 2009 proxy seasons combined, there have been about 200 companies with shareholders voting on compensation practices.
In 2009, under the American Recovery and Reinvestment Act, all companies receiving funds from the US Treasury (TARP) were required to include a non-binding advisory vote on compensation to the highest paid group of executives. This resulted in approximately 400 companies required to hold such vote, mostly banks.
On July 21, 2010 the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Act”), was signed into law by President Obama and includes a provision requiring public companies to allow shareholders a non-binding advisory vote on executive compensation.
Specifically, the Act requires:
A vote at least once every three years, beginning with the first shareholder meeting that occurs after January 21, 2011. Therefore, say-on-pay will be required for many public companies this upcoming proxy season.
Also at this first annual meeting, the shareholders must decide on whether the vote should be held every one, two or three years (thereafter a vote on frequency must be held by a separate resolution no less often than every six years).
What are Shareholders actually voting on?
With the non-binding advisory vote, what are shareholders actually going to be voting on? Are they voting on the amount of compensation paid? Are they voting on the compensation philosophy of the company? Are they voting on the types and delivery of compensation? Ultimately, you would think the vote would be on all of the above but the compensation philosophy seems to be the most important issue. Poor compensation philosophy can lead to many other problems, specifically overpayment for poor performance.
Issues to Consider
As with many of the provisions in the Act, there will unintended consequences of the new legislation. Here are a few issues to consider when asking shareholders to vote on executive compensation:
Companies will need to revise proxy statements to include the mechanics of voting on compensation. Will the Board make a recommendation on the vote?
Institutional shareholder advisory services will have a greater influence on compensation practices as a result of the vote and therefore companies will more likely want to comply with mandates from such advisory firms (i.e. employment agreements, change in control provisions, severance arrangements).
Ongoing educational efforts of a company’s compensation plans and philosophy will be necessary to inform shareholders required to vote, especially since retail shareholders/brokers will need instructions from beneficial owners in order to vote the shares in favor of compensation plans (no instructions = a no vote).
While the vote is “non-binding”, Directors will be forced to react to such votes or risk a “withhold” vote on their re-election as board members. In the 2010 proxy season, there were three companies that received a no vote (KeyCorp, Occidental Petroleum and Motorola)…so it can happen.
A more subtle influence of the Say on Pay shareholder vote of confidence will be the risk of focusing senior management on shorter term performance results so that a company’s annual performance will justify higher compensation when a longer-term, strategic investment focus would result in greater shareholder value in the long run.
With the many issues to consider and the potential of getting a negative vote from shareholders on compensation practices, companies would be wise to get an early start on reviewing current practices and seek advice on their proxy draft now.
In 2002, as a result of a few high profile cases of corporate wrongdoing and scandalous financial behavior, Congress passed The Sarbanes-Oxley Act of 2002 that required clawback of incentive compensation from the CEO and CFO. According to Equilar’s 2009 Fortune 100 Clawback Policy Report, between 2006 and 2009 the percentage of companies reporting Clawback Policies jumped from 17% to 72%. Furthermore, as a requirement of all banks participating in the Troubled Asset Relief Program (TARP), all incentive compensation paid to the top 20 highest paid executives must be subject to clawback policies in the case of materially inaccurate financial data or performance metrics. So, the public company arena has an increasingly heightened awareness of such a risk reduction policy. And now most recently, The Dodd-Frank Wall Street Reform and Protection Act of 2010 includes a provision requiring Clawback Policies.
Dodd-Frank Wall Street Reform and Consumer Protection Act 2010
The new law signed by President Obama on July 21, 2010 requires all companies listed on national security exchanges to develop and adopt a policy to recoup incentive-based compensation upon the discovery of misreported or erroneous financial information. The requirements under the new law are more far reaching than those under Section 304 of the Sarbanes-Oxley Act (SOX 304).
Provisions of the Dodd-Frank Act
Any time a company is required to prepare an accounting restatement as a result of material noncompliance with any financial reporting requirement the clawback policy will be triggered. This expands the requirement under SOX 304 which applied only when a restatement of financial statements is “required” and is the result of “misconduct”.
The clawback policy would apply to all incentive-based compensation (cash or equity) paid to any former or current executive. SOX 304 applied only to the CEO and CFO.
The look-back period is for the thirty-six (36) months preceding the date on which the restatement is required. The look-back period under SOX 304 is only twelve months.
The amount to be recovered would be the difference in the amount actually paid based on the erroneous data and the amount that would have been paid based on the corrected data.
Policy Design/Review Considerations
Review any existing policies to determine any possible changes required by new law.
Identify the specific party required to enforce the policy (i.e. senior risk assessment officer, Compensation Committee, full Board of Directors)
Determine what method of recoupment will be necessary for recovery of any incorrect payments (i.e. deduction from future payments/awards, enforcement of re-payment by executive or potential litigation against former executives)
Determine whether policy should be more expansive than required by Dodd-Frank Act to include poor performance, violation of non-competes, negligence, etc.
Determine if policy is strong enough to be a mitigating factor to deter excessive risk under SEC rules which requires narrative disclosure in the CD&A in proxy.
Conduct a review of all compensation arrangements (i.e. incentive plan documents, employment agreements, equity award agreements) to insure proper integration with a new clawback policy.
So, while there may be many “unintended consequences” of the Dodd- Frank Act and there is much final government regulation yet to be published, it appears that Clawback Policies contribute to risk mitigation in compensation and are likely here to stay.