Tag: Executive Compensation


SEC Proposes Rules on Mandatory Clawback Policies

Renata J. Ferrari is partner tax & benefits department at Ropes & Gray LLP. This post is based on a Ropes & Gray Alert.

On July 1, 2015, the Securities and Exchange Commission proposed rules to require issuers of securities listed on U.S. stock exchanges to adopt and enforce clawback policies applicable to incentive-based compensation received by current and former executives in the three-year period preceding the date the issuer is required to prepare an accounting restatement due to material noncompliance with financial reporting requirements. The proposed rules would implement the “no fault” clawback rule requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Section 10D of the Securities Exchange Act of 1934, as amended).

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Clawbacks of Erroneously Awarded Compensation

Michael S. Piwowar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Piwowar’s recent remarks at a recent open meeting of the SEC; the full text is available here. The views expressed in the post are those of Commissioner Piwowar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

A few months ago, the baseball world celebrated the 90th birthday of Yogi Berra, the legendary former catcher and manager for the New York Yankees. Yogi Berra is well-known for his witty comments, often referred to as “Yogi-isms.” [1] Several come to mind today, as we consider another rulemaking related to executive compensation.

“Pair up in threes.”

Following our earlier efforts on hedging and pay versus performance, today’s proposal is the third relating to executive compensation that we have considered in 2015. The Commission has yet again spent significant time and resources on a provision inserted into the Dodd-Frank Act that has nothing to do with the origins of the financial crisis and affects Main Street businesses that are not even part of the financial services sector. Why does the Commission continue to prioritize our agenda with these types of issues, when rulemakings that are directly related to the financial crisis remain unaddressed?

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Does the SEC’s New “Compensation Actually Paid” Help Shareholders?

Ira Kay is a Managing Partner and Blaine Martin is a Consultant at Pay Governance LLC. This post is based on a Pay Governance memorandum.

On April 29, 2015, the SEC released proposed rules on public company pay‐for‐performance disclosure mandated under the Dodd‐Frank Act. Pay Governance has analyzed the proposed rules and the implications for our clients’ proxy disclosures and pay‐for‐performance explanations to investors. We are concerned about the validity of describing a company’s pay‐for‐performance alignment using the disclosure mandated under the SEC’s proposed rules, and its implications for Say on Pay votes.

The disclosure of “compensation actually paid” (CAP) as defined by the SEC may prove helpful for investors and other outside parties to estimate the amount of compensation earned by executives, in contrast to the compensation opportunity as disclosed in the Summary Compensation Table (SCT). However, the SEC’s proposed rules are explicitly intended to compare executive compensation earned with company stock performance (TSR), per the relevant section of the Dodd‐Frank legislation. [1] If the rules are intended to help shareholders understand the linkage between executive compensation programs and stock performance, then the technical nuance of the proposed methodology may be problematic.

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Making Executive Compensation More Accountable

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent open meeting of the SEC; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff. Related research from the Program on Corporate Governance about CEO pay includes Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

When it comes to compensation, Americans believe you should earn your money. They also believe, just as strongly, that you should not keep what you did not earn. It’s fundamental to our values. However, when companies have to restate their financial statements because they violated applicable reporting requirements, their executives may not be required to reimburse any incentive-based compensation that was erroneously paid. In other words, they get to keep what they never should have received in the first place.

And, quite often, we are talking about very large amounts. In today’s corporate world, many executives are earning eye-catching sums. Much of the increase in executive compensation is commonly attributed to the impact of incentive-based compensation, including equity and other performance-based compensation plans.

Incentive-based compensation plans are intended to align the interests of company managers and shareholders. However, when a company is required to issue a restatement, and when its executives have been paid compensation based on inflated financial results, this alignment disappears. In such cases, it is only fair that these erroneously awarded payments be recovered.

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Managerial Ownership and Earnings Management

Phil Quinn is Assistant Professor of Accounting at the University of Washington. This post is based on an article by Mr. Quinn.

In my paper, Managerial Ownership and Earnings Management: Evidence from Stock Ownership Plans, which was recently made publicly available on SSRN, I exploit the initiation of ownership requirements to examine the relation between managerial ownership and earnings management. Prior work provides mixed evidence on the relation between managerial ownership and earnings management. Many studies provide evidence of a positive relation between managerial ownership and earnings management, which is consistent with an increase in stock price increasing the portfolio value of high-ownership managers more than the value of low-ownership managers (i.e., the “reward effect”) (Cheng and Warfield 2005; Bergstresser and Philippon 2006; Baber, Kang, Liang, and Zhu 2009; Johnson, Ryan, and Tian 2009). Other work notes that earnings management is a risky activity and posits that risk-adverse managers will be less likely to engage in risky activities as their ownership increases. Consistent with the “risk effect” increasing with managerial ownership, several studies find no relation or a negative relation between earnings management and managerial ownership (Erickson, Hanlon, and Maydew 2006; Hribar and Nichols 2007; Armstrong, Jagolinzer, and Larcker 2010). Armstrong, Larcker, Ormazabal, and Taylor (2013) note that the theoretical reward effect and risk effect are countervailing forces, and the countervailing forces may explain why prior empirical work finds mixed evidence on the relation between ownership and earnings management. By examining stock ownership plans, a governance reform that limits the reward effect, I seek to inform the discussion on the relation between ownership and earnings management.

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Shareholder Activism and Executive Compensation

Jeremy L. Goldstein is founder of Jeremy L. Goldstein & Associates, LLC. This post is based on a publication by Mr. Goldstein. Related research from the Program on Corporate Governance about CEO pay includes Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

In today’s environment in which all public companies—no matter their size, industry, or performance—are potential targets of shareholder activists, companies should review their compensation programs with an eye toward making sure that the programs take into account the potential effects of the current wave of shareholder activism. In this regard, we have provided below some considerations for public company directors and management teams.

“Say on Pay”: Early Warning Sign

Low levels of support for a company’s “say on pay” vote can serve as an early warning sign for both companies and activists that shareholders may have mixed feelings about management’s performance or a board’s oversight. An activist attack following a failed vote may be particularly inopportune for target companies because a failed vote can result in tension between managements and boards. Moreover, activists will not hesitate to use pay as a wedge issue, even if there is nothing wrong with a company’s pay program. Companies should get ahead of potential activists by (1) understanding how their pay programs diverge from standards of shareholders and proxy advisors, (2) developing a robust, year-round program of shareholder engagement by management and independent directors, and (3) considering appropriate changes to pay and governance structures if advisable. Companies that are the most aggressive at shareholder outreach and develop the best relationships with both the investment and the governance representatives of their major holders will be best able to address an activist attack if it occurs.

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US Proxy Season Halftime Report—Governance Trends

Frank B. Glassner is the Chief Executive Officer of Veritas Executive Compensation Consultants, LLC (Veritas). This post is based on a Veritas publication.

As we hit the halfway point for the 2015 U.S. proxy season, a number of trends related to governance practices are carrying through from recent years, an analysis of ISS Voting Analytics data shows.

Director Elections

Shareholders have largely endorsed directors standing for election in 2015, with average support levels of upwards of 96 percent, similar to last year. However, as is the case every year, a number of directors have not fared well at the ballot box. Fourteen directors have failed to receive majority support so far this season, compared with 12 board members at this time last year.

The lion’s share (12 of the 14) of year-to-date 2015 failed director votes have been at firms outside the Russell 3000 index. On a sector basis, most of the failed director elections have occurred at firms in the Technology Media and Telecom sector (with seven failed votes) and financial services firms (3 failed votes). Companies in the financial services sector topped last year’s list with the most failed director votes.

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Shareholders Defeat Mandatory Deferral Proposal

John R. Ellerman is a founding Partner of Pay Governance LCC. The following post is based on a Pay Governance memorandum by Mr. Ellerman, Lane T. Ringlee, and Maggie Choi.

Many large U.S. based multinational banking and financial services corporations have implemented executive compensation clawback policies that require the cancellation and forfeiture of unvested deferred cash awards or performance share unit awards. These policies typically condition the cancellation of deferred compensation if it is determined that an executive engaged in misconduct, including failure to supervise or monitor individuals engaging in inappropriate behaviors that caused harm to the organization’s operations. Policies also apply to unvested deferred awards that could be vested and paid based on inaccurate financial statements. Most of the clawback policies have been implemented in response to the Dodd-Frank financial legislation of 2010 that requires public companies to adopt clawback policies to protect shareholder interests. The Securities and Exchange Commission is expected to release final guidance with respect to clawbacks later this year.

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Latest CD&A Template Offers Best Practices, Is Win-Win for Issuers, Investors

Matt Orsagh is a director at CFA Institute.

To help companies produce a more clear and concise executive compensation report that attends to the needs of both companies and investors, CFA Institute has released an updated Compensation Discussion & Analysis (CD&A) Template. It is an update of the 2011 template of the same name and aims to help companies draft CD&As that serve as better communications tools, not simply as compliance documents.

CFA Institute worked with issuers, investors, proxy advisers, compensation consultants, legal experts and other associations to update the manual so it would best serve the needs of investors and issuers. One of the main enhancements in the latest version of the template is a graphic executive summary that presents the main information investors are looking for in a concise format that takes up only one or two pages.

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SEC Proposes “Pay Versus Performance” Rule

Edmond T. FitzGerald is partner and head of the Executive Compensation Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum; the complete publication, including Appendix, is available here. Related research from the Program on Corporate Governance about CEO pay includes Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

On April 29, 2015, a divided Securities and Exchange Commission proposed requiring U.S. public companies to disclose the relationship between executive compensation and the company’s financial performance. [1] The proposed “pay versus performance” rule, one of the last Dodd-Frank Act rulemaking responsibilities for the SEC, mandates that a company provide, in any proxy or information statement:

  • A new table, covering up to five years, that shows:
    • compensation “actually paid” to the CEO, and total compensation paid to the CEO as reported in the Summary Compensation Table;
    • average compensation “actually paid” to other named executive officers, and average compensation paid to such officers as reported in the Summary Compensation Table; and
    • cumulative total shareholder return (TSR) of the company and its peer group; and
  • Disclosure of the relationship between:
    • executive compensation “actually paid” and company TSR; and
    • company TSR and peer group TSR.

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