Compensation Season 2015

Boards of directors will soon shift attention to the 2015 compensation season. Key considerations in the year ahead include the following:

1. Be Prepared for Shareholder Activists. Companies today are more vulnerable to activist attacks than ever before. Companies should therefore ensure that they understand how their change in control protections function if an activist obtains a significant stake in the company or control of the board. A change in board composition can trigger the application of the golden parachute excise tax under Section 280G of the Internal Revenue Code and can result in negative tax consequences for executives and the company. In addition, in the age of performance awards and double-trigger vesting, clarity about the impact of a change in control on performance goals matters more than ever. Appropriate protections ensure that management will remain focused on shareholder interests during a period of significant disruption; inadequate protections can result in management departures at a time when stability is crucial.

2. Manage Say-on-Pay Proactively. Companies should evaluate in advance of proxy season whether or not they expect to be vulnerable in the upcoming say-on-pay vote. The single biggest reason for a negative ISS recommendation is a perceived pay for performance disconnect. If a company anticipates a challenging say-on-pay vote, it should proactively reach out to large investors throughout the year (not just during proxy season), communicate the rationale for the company compensation programs and give investors an opportunity to voice any concerns. Fulsome disclosure in the annual meeting proxy statement of proactive shareholder communications may improve a company’s say-on-pay results.

3. Avoid Litigation Pitfalls. The plaintiffs’ bar continues to target executive compensation matters. Set forth below are the principal categories of compensation-related litigation in recent years and some suggestions that may mitigate the likelihood of such actions.

• Disclosure Regarding New or Amended Equity Plans. Additional disclosure regarding dilution analysis, the methodology for determining the requested number of shares and related matters may reduce the likelihood of this type of suit.
• Compliance with Plan Terms and/or Section 162(m). Companies should take care to administer plans in accordance with their terms, including applicable limits on share grants and cash incentive payments. In addition, companies should draft plans that provide flexibility to grant non-deductible awards and should include proxy statement disclosure that highlights that flexibility. Compensation committee materials should clearly identify the performance goals that are intended to satisfy the Section 162(m) performance-based exception and any separate business goals that are not intended to be threshold goals for purposes of Section 162(m).
• Director Equity Grant Limitations. Consider including in new or amended omnibus equity plans reasonable annual limits on the levels of individual grants to directors. These limits may help to avoid claims challenging the level of director compensation.

4. Be Mindful of ISS, but Don’t Lose Sight of the Big Picture. Management and compensation committees should understand the potential consequences of their decisions under applicable ISS policies, but should not waver in their commitment to create a culture that attracts and retains talented personnel who will contribute to the long-term success of the company. The ISS position on a particular issue does not always serve the best interests of stockholders.

5. Keep an Eye Out for Dodd-Frank Regulations. We continue to await final regulations regarding pay ratio disclosure and proposed regulations on clawbacks, disclosure of pay for performance and disclosure of hedging by employees and directors. Based on SEC pronouncements to date, it would be surprising if any of the disclosure rules take effect prior to the 2016 proxy season. If the final rules regarding pay ratio disclosure are consistent with the proposed regulations, companies will need significant lead time to prepare compliant disclosure, especially those companies with large employee populations located in multiple countries.

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Plaintiffs’ lawyers, shareholder activists and the proxy advisory firms present a significant challenge to designing and implementing effective executive compensation programs. These groups invent new issues with each new proxy season, distracting directors from core principles and objectives. The most effective companies navigate this obstacle course of activism, strike suits and short-termism by resolutely returning to core principles that promote the long-term interests of stockholders.