2019 Compensation Committee Guide

Jeannemarie O’Brien, David Kahan, and Michael Schobel are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Ms. O’Brien, Mr. Kahan, Mr. Schobel, Michael J. Segal, Andrea K. Wahlquist, and Adam J. Shapiro. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation by Lucian Bebchuk and Jesse Fried.

The key challenge for compensation committees is to approve compensation programs that directors believe will promote the long-term interests of a company and its shareholders, while taking into account shareholder views and maximizing investor support for those programs.

Three notable developments affected the public company compensation landscape in 2018. First, the elimination by the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Reform Act”) of the performance-based exception to the $1 million per-person annual limit on the deductibility of compensation for certain public company executives under Section 162(m) of the U.S. Internal Revenue Code (the “Code”) resulted in a significant increase in 2018 in nondeductible compensation. However, the 2017 Tax Reform Act did not result in dramatic changes in compensation design, as most companies remained committed—both for substantive reasons and due to investor relations considerations—to traditional performance-based compensation paradigms. Second, the 2018 proxy season featured the first “pay ratio” disclosure under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). Institutional Shareholder Services (“ISS”) and Glass Lewis have thus far not taken pay ratio disclosure into their recommendations on say-on-pay votes. However, many companies are deeply focused on the issues of perception associated with pay ratio disclosure. In some cases, the most challenging messaging is internal, to employees intensely interested in the pay of the “median” employee that is required to be disclosed in the pay ratio discussion in the proxy. Third, the SEC issued long-awaited final regulations on the Dodd-Frank statutory mandate requiring companies to disclose hedging policies that apply to executives or directors.

As public companies grapple with changes in law governing compensation matters and the impact of the new disclosure rule, they also face ongoing external pressure on executive pay issues, most notably from investor groups that engage on compensation issues. Companies must carefully monitor shareholder activism and its impact on compensation arrangements. In particular, if an activist obtains a significant equity stake in a company, its compensation committee will need to consider the appropriate employee retention incentives and protections to ensure that management remains focused on shareholder interests. The time to adopt appropriate management protections with the least shareholder pushback is before an activist shows up. Additionally, the 2019 proxy season continues to witness a proliferation of shareholder proposals related to compensation. Finally, political and social activists have taken an increasing interest over the past year in the relationship between public policy objectives (such as environmental, social, and governance goals (“ESG”)) and executive compensation programs. Boards should be mindful in designing compensation that healthy corporations focus not only on traditional measures of profit maximization, but also on serving all stakeholders, including employees and communities; companies that fairly balance the needs of all constituencies are most likely to achieve long-term financial success.

Against this backdrop, as in prior years, there is a continued need to proactively engage with large investors in order to provide them the opportunity to voice concerns they may have over a company’s compensation programs in connection with any upcoming say-on-pay vote. 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 ISS or Glass Lewis. Companies should also be mindful that large institutional investors are actively engaged in monitoring compensation practices and making their views known.

Finally, directors should bear in mind the heightened sensitivity to pay packages that could be deemed “excessive,” both as to executives and as to the directors themselves. This is particularly true in today’s environment, which has witnessed a marked increase in litigation on executive and, increasingly, director compensation matters, a trend we expect will continue, at least in the short run. To that end, companies may wish to consider including, in new or amended equity plans, provisions specifying either the precise amount and form of director compensation (which might include both cash and equity) to be paid or meaningful director-specific individual award limits. Such limits may help avoid and defend claims challenging the level of director compensation, whether by shareholders (more accurately, plaintiffs’ law firms in search of shareholders) or, also increasingly, firms such as ISS.

These challenges notwithstanding, a compensation committee that follows normal procedures and considers the advice of legal counsel and an independent compensation consultant should not fear being second-guessed by the courts regarding executive compensation. To date, courts continue to apply the business judgment rule and respect executive compensation decisions, so long as the directors act on an informed basis, in good faith, and not in their personal self-interest. The ability to recruit, motivate and retain highly qualified executives remains a core mandate of the compensation committee and is essential to the long-term success of a company.

The primary objectives of the complete publication are to describe the duties of public company compensation committee members and to provide information to enable compensation committee members to function most effectively. Like prior versions, the Guide begins with an overview of key responsibilities and subsequently addresses more specific substantive issues.

  • 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 this Guide focuses on shareholder proposals, relations and executive compensation litigation, including a discussion of say-on-pay votes, the ongoing influence of proxy advisory firms, and the relevance of ESG-related and other non-financial goals in compensation arrangements.
  • The discussion then shifts to compensation committee composition, meetings and charters (Chapters VIII, IX and X).
  • Finally, the Guide addresses the compensation of directors, including a discussion of recent director compensation litigation (Chapter XI).
  • Examples of compensation committee charters for both NYSE- and NASDAQ-listed companies are included as Exhibits A and B.

The complete publication, including footnotes, is available here.

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