Tag: Equity-based compensation


Trends in Board of Director Compensation

The following post comes to us from Pay Governance LLC and is based on a Pay Governance memorandum by Steve Pakela and John Sinkular.

The following post comes to us from Pay Governance LLC and is based on a Pay Governance memorandum by Steve Pakela and John Sinkular.

Over the past 15 years, the methods of compensating non-employee directors have changed in tandem with the risk and workload of being a director. The catalyst for change over this time period includes a variety of regulatory requirements, such as Sarbanes-Oxley and Dodd Frank, enhanced proxy disclosure rules and increases in shareholder activism. By way of examples, Audit Committees meet more frequently and must have at least one qualified financial expert, and Compensation Committees have greater workloads. Today’s corporate director needs to dedicate more time to the job, assume greater risk, and meet higher qualification standards. Arguably, these issues, and newer issues such as director tenure limits, have reduced the pool of available individuals who are willing to serve as a director. As with all things impacted by supply and demand, the total compensation provided to directors has increased. Over the past decade, total director remuneration has grown by approximately 5% per year on average.

With the changing role and the increase in total compensation, the design of director compensation programs has changed over time as well. The basic construct of the director compensation arrangement continues to be a mix of cash and equity. However, the means of delivering these two elements has changed rather dramatically over the past decade. Below we review key elements of director compensation programs.

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IRS Releases Final Regulations Under Section 162(m)

The following post comes to us from Edmond T. FitzGerald, partner and head of the Executive Compensation Group at Davis Polk & Wardwell LLP, and is based on a Davis Polk client memorandum by Kyoko Takahashi Lin.

The following post comes to us from Edmond T. FitzGerald, partner and head of the Executive Compensation Group at Davis Polk & Wardwell LLP, and is based on a Davis Polk client memorandum by Kyoko Takahashi Lin.

On March 31, 2015, the Internal Revenue Service published final regulations under Section 162(m) of the Internal Revenue Code. As it did when it proposed these regulations in 2011, the IRS has indicated that these regulations are not intended to reflect substantive changes to existing requirements of Section 162(m), but rather to clarify them.

The final regulations clarify two requirements for exceptions from the Section 162(m) tax deductibility limit:

  • the need for per-employee limits on equity awards in order to qualify stock options and stock appreciation rights (SARs) for the “qualified performance-based compensation” exception; and
  • the treatment of restricted stock units (RSUs) or phantom stock arrangements under the transition period exception for certain compensation “paid” by newly public companies.

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The Benefits of Limits on Executive Pay

The following post comes to us from Peter Cebon of the University of Melbourne and Benjamin Hermalin, Professor of Economics at the University of California, Berkeley. Work from the Program on Corporate Governance about CEO pay includes: The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers, and Urs Peyer (discussed on the Forum here); Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here); and Lucky CEOs and Lucky Directors by Lucian Bebchuk, Yaniv Grinstein and Urs Peyer (discussed on the Forum here).

The following post comes to us from Peter Cebon of the University of Melbourne and Benjamin Hermalin, Professor of Economics at the University of California, Berkeley. Work from the Program on Corporate Governance about CEO pay includes: The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers, and Urs Peyer (discussed on the Forum here); Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here); and Lucky CEOs and Lucky Directors by Lucian Bebchuk, Yaniv Grinstein and Urs Peyer (discussed on the Forum here).

Our paper, When Less Is More: The Benefits of Limits on Executive Pay, forthcoming in the Review of Financial Studies, addresses the question of whether limits on executive compensation harm or benefit shareholders. In particular, our model shows that if regulation limits executive compensation, this can make it possible for the board to give the CEO incentives that are both more effective and less costly, and for the two parties to create a relationship that is more collaborative. Among the implications—some of which we are exploring in a companion paper in progress—is this collaborative relationship makes it more attractive for the CEO to pursue long-run strategies (e.g., organic growth) that are more profitable than the short-run strategies (e.g., mergers and acquisitions) they would have pursued if firms had to rely on stock-based compensation for their executives.

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Aligning the Interests of Company Executives and Directors with Shareholders

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement; 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.

Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s recent public statement; 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.

Today [February 9, 2015], the Commission issued proposed rules on Disclosure of Hedging by Employees, Officers and Directors. These congressionally-mandated rules are designed to reveal whether company executive compensation policies are intended to align the executives’ or directors’ interests with shareholders. As required by Section 955 of the Dodd-Frank Act, these proposed rules attempt to accomplish this by adding new paragraph (i) to Item 407 of Regulation S-K, to require companies to disclose whether they permit employees and directors to hedge their companies’ securities.

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ISS 2015 Equity Plan Scorecard FAQs

Carol Bowie is Head of Americas Research at Institutional Shareholder Services Inc. (ISS). This post relates to ISS’ Equity Plan Scorecard for 2015.

Carol Bowie is Head of Americas Research at Institutional Shareholder Services Inc. (ISS). This post relates to ISS’ Equity Plan Scorecard for 2015.

General Questions

1. What is the basis for ISS’ new scorecard approach for evaluating equity compensation proposals?

The new policy will allow more nuanced consideration of equity incentive programs, which are critical for motivating and aligning the interests of key employees with shareholders, but which also fuel the lion’s share of executive pay and may be costly without providing superior benefits to shareholders. While most plan proposals pass, they tend to get broader and deeper opposition than, for example, say-on-pay proposals (e.g., only 60% of Russell 3000 equity plan proposals garnered support of 90% or more of votes cast in 2014 proxy season, versus almost 80% of say-on-pay proposals that received that support level). The voting patterns indicate that most investors aren’t fully satisfied with many plans.

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Tying Incentives of Executives to Long-Term Value Creation

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal. Research from the Program on Corporate Governance on long-term incentive pay includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal. Research from the Program on Corporate Governance on long-term incentive pay includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

There is an important difference between the price paid for a business enterprise and the intrinsic value of that enterprise. As Benjamin Graham said, “Price is what you pay; value is what you get.” Warren Buffett has made himself and many others wealthy by understanding this difference and making investments accordingly.

Part I of this post looks briefly at the intrinsic value versus the market price (sometimes the latter is referred to as market value or market cap) of a publicly traded corporation. Part II looks at current design of long-term incentives awarded to the management of such corporations. These awards tend to be tied to short-term increase in the market price of the corporation’s stock. Part III suggests a way in which long-term incentive awards might be tied more to generators of long-term value of the corporations awarding them.

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Long-term Incentive Grant Practices for Executives

The following post comes to us from Frederic W. Cook & Co., Inc., and is based on a publication by James Park and Lanaye Dworak. The complete publication is available here. An additional publication authored by Mr. Park on the topic of executive compensation was discussed on the Forum here. Research from the Program on Corporate Governance on long-term incentive pay includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed on the Forum here.

The following post comes to us from Frederic W. Cook & Co., Inc., and is based on a publication by James Park and Lanaye Dworak. The complete publication is available here. An additional publication authored by Mr. Park on the topic of executive compensation was discussed on the Forum here. Research from the Program on Corporate Governance on long-term incentive pay includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed on the Forum here.

The use of long-term incentives, the principal delivery vehicle of executive compensation, has long been sensitive to external influences. A steady source of this influence has come under the guise of legislative reform with mixed results. In 1950, after Congress gave stock options capital gains tax treatment, the use of stock options surged as employers sought to avoid ordinary income tax rates as high as 91%. Some forty years later, Congress added Section 162(m) to the tax code in an attempt to rein in excessive executive pay by limiting the deduction on compensation over $1 million to certain executives. Stock options qualified for a performance-based exemption leading to a spike in stock option grants to CEOs at S&P 500 companies.

Fast forward twenty years and the form and magnitude of long-term incentives continues to be a hot button populist issue. The 2010 Dodd Frank Act introduced U.S. publicly-traded companies to Say on Pay giving shareholders a direct channel to voice their support or opposition for a company’s pay practices. Another legislative addition to the litany of unintended consequences, Say on Pay has magnified the growing number of interested parties, increased the influence of proxy advisory groups such as Institutional Shareholder Services (ISS) and Glass Lewis, heightened sensitivity to federal regulators, and provoked the increased interaction of activist investors.

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2014 Director Compensation Report

The following post comes to us from Eva Gencheva, executive compensation consultant at Frederic W. Cook & Co., Inc., and is based on the summary of a FW Cook report; the complete report is available here.

The following post comes to us from Eva Gencheva, executive compensation consultant at Frederic W. Cook & Co., Inc., and is based on the summary of a FW Cook report; the complete report is available here.

Frederic W. Cook & Co. Inc.’s 2014 Director Compensation Report indicates that non-employee director compensation increased modestly since last year, with increases ranging from 4% to 7%. Although no new design trends were observed, the streamlining of director compensation continues through (1) replacing meeting fees with higher cash retainers implying that director attendance is a prerequisite of board service, (2) denominating equity grants as a dollar value rather than as a number of shares to mitigate year-over-year valuation changes, and (3) shifting from stock options to full-value shares to strengthen the alignment of directors’ and shareholders’ interests.

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Strategic News Releases in Equity Vesting Months

The following post comes to us from Alex Edmans, Professor of Finance at London Business School; Luis Goncalves-Pinto of the Department of Finance at the National University of Singapore; Yanbo Wang of the Finance Area at INSEAD; and Moqi Xu of the Department of Finance at the London School of Economics.

The following post comes to us from Alex Edmans, Professor of Finance at London Business School; Luis Goncalves-Pinto of the Department of Finance at the National University of Singapore; Yanbo Wang of the Finance Area at INSEAD; and Moqi Xu of the Department of Finance at the London School of Economics.

In our paper, Strategic News Releases in Equity Vesting Months, which was recently made publicly available on SSRN, we study the link between the equity vesting schedules of CEOs and the timing of corporate news releases. We show that, in months in which the CEO has equity vesting, the firm releases more news. This is an easy way to pump up the short-term stock price, as news attracts attention to the stock. This attention also increases trading volume, which allows the CEO to cash out his equity in a more liquid market. Indeed, we find that these news releases lead to significant increases in the stock price and trading volume in a 16-day window, but the effect dies down over 31 days, consistent with a temporary attention boost. The median CEO cashes out all of his vesting equity within seven days—within the window of price and volume inflation.

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ISS, Share Authorizations, and New Data Verification Process

The following post comes to us from John R. Ellerman, founding partner of Pay Governance, and is based on a Pay Governance memorandum by Mr. Ellerman.

The following post comes to us from John R. Ellerman, founding partner of Pay Governance, and is based on a Pay Governance memorandum by Mr. Ellerman.

Publicly traded companies are required by the SEC and the stock exchanges to obtain shareholder approval when such companies seek to implement a new long‐term equity plan or increase the share reserve pursuant to such plans.

Companies comply with this requirement by seeking shareholder approval through the annual proxy process. Institutional Shareholder Services (ISS), the large proxy advisory firm retained by many institutional investors for proxy voting advice, offers its services to institutional clients by evaluating such proposals. One of the tools used by ISS in developing its voting advice is a financial model referred to as the Shareholder Value Transfer (SVT) Model that attempts to assign a cost to each company’s equity plan. ISS’ proprietary SVT model contains numerous hidden values and algorithms a company cannot readily replicate. If the SVT Model results in an assigned cost that falls outside the boundaries of what is acceptable to ISS, ISS will submit a negative vote recommendation.

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