Compensation Committee Guide

Michael J. Segal is senior partner in the Executive Compensation and Benefits Department of Wachtell, Lipton, Rosen & Katz. This post is based on the introduction to a Wachtell Lipton publication by Mr. Segal, Jeannemarie O’BrienAdam J. ShapiroAndrea K. Wahlquist, and David E. Kahan. The complete publication is available here.

The past year has been marked by a continued focus by shareholders and investor groups on executive compensation, and a related continued need for compensation committees to proactively manage their companies’ communications with shareholders and proxy advisory firms—both in the context of the nonbinding, advisory “say-on-pay” votes required by Dodd-Frank and also as preemptive actions against possible shareholder activists seeking the means by which to challenge board composition. 2015 also witnessed finalization by the U.S. Securities and Exchange Commission (the “SEC”) of the long-awaited pay ratio disclosure rules, and continued action from the plaintiffs’ bar challenging compensation decisions.

Against this backdrop, the key challenge for compensation committee members continues to be to approve compensation programs that directors believe are right for their companies, while maintaining an understanding of shareholder views and an ability to communicate the appropriateness of their compensation decisions sufficient to avoid criticism that could undermine directors’ abilities to act in their company’s best interest. In our post Compensation Season 2016, we identified the following key considerations for compensation committees in the upcoming compensation season:

  • Say-on-pay voting, and the continued need to proactively engage with large investors in order to provide them the opportunity to voice concerns they may have. Clear communication in the proxy statement’s Compensation Disclosure and Analysis regarding any changes made in response to such discussions can help dilute negative vote recommendations that could be made by Institutional Shareholder Services (“ISS”) or other proxy advisory firms.
  • New Dodd-Frank regulations regarding pay ratio disclosure and proposed regulations regarding disclosure of pay for performance, clawbacks of executive compensation and the potential for proposed regulations regarding disclosure rules for employee and director hedging.
  • Continued monitoring of shareholder activism and how any such activity can impact compensation arrangements, especially if an activist obtains a significant equity stake in the company, and consideration of appropriate employee retention incentives and protections to ensure that management remains focused on shareholder interests, including ensuring sufficient equity plan share reserves are available for long-term incentive grants. Compensation committees should design compensation programs with great care, focusing first and foremost on the incentives that the programs promote.
  • Directors should also bear in mind the heightened sensitivity to pay packages that could be deemed “excessive.” This is particularly true in today’s environment, which has witnessed a marked increase in litigation on executive compensation matters, a trend we expect will continue at least in the short run. Given the ongoing shift in the corporate governance landscape, there is also a continuing focus by directors on the proper role of a compensation committee.

These challenges notwithstanding, a compensation committee that follows normal procedures and considers the advice of legal counsel and an independent consultant should not fear being second-guessed by the courts, which continue to respect executive compensation decisions so long as the directors act on an informed basis, in good faith and not in their personal self-interest. In the final analysis, the ability to recruit and retain highly qualified executives is essential to the long-term success of a company.

The primary objectives of the complete publication (available here) are to (1) describe the duties of public company compensation committee members and (2) provide information to enable compensation committee members to function most effectively. Like our prior Guides, the 2016 Guide continues to be structured in a manner intended to first provide compensation committee members an overview of their responsibilities, before delving in more detail into the primary substantive issues with which compensation committees most often deal, as follows:

  • The Guide begins with a discussion of the responsibilities of the public company compensation committee and its members, including those imposed by the various securities markets and Dodd-Frank, including disclosure requirements regarding executive and director compensation (Chapter I). We then review the fiduciary duties of compensation committees and their members under various applicable laws (Chapter II).
  • The Guide then outlines different means of compensating executives and the tax and other rules that apply to compensation arrangements (Chapters III and IV), followed by a discussion of change in control arrangements (Chapter V). We next examine regulation of compensation at financial institutions (Chapter VI).
  • Chapter VII of the Guide focuses on shareholder proposals, relations and litigation, including a discussion of say-on-pay votes and the ongoing influence of proxy advisory firms.
  • The discussion then shifts to compensation committee composition, meetings and charters (Chapters VIII, IX and X).
  • Finally, the Guide addresses the compensation of directors (Chapter XI).
  • Examples of compensation committee charters for both NYSE and NASDAQ listed companies are also included as Exhibits A and B.

The complete publication is available here.

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