Compensation Season 2022

Adam J. Shapiro, David E. Kahan, and Michael J. Schobel are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Mr. Shapiro, Mr. Kahan, Mr. Schobel, Jeannemarie O’Brien, Andrea K. Wahlquist, and Erica E. Bonnett. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

U.S. companies continue to demonstrate resilience following another year in which the pandemic imposed itself on world events. Although 2021 did not deliver a full reopening, corporate activity thrived in spite of ongoing uncertainty around “return to work,” building on momentum and lessons learned from 2020. As the impact of the pandemic subsides, company culture, talent retention and business objectives will shape the long-term workplace landscape. We identify below some of the key factors that may shape the 2022 compensation season.

Steady Rise of ESG. ESG-related goals are increasingly prevalent in annual incentive programs, with a meaningful year-over-year increase from 2020 to 2021. Over the next few years, we expect that use of these metrics will continue to increase and take on greater relevance. With so much attention on ESG objectives, it is vital for companies to carefully consider the goals that they establish and the manner in which they disclose those goals. Making well-intentioned commitments that go unfulfilled can backfire. And changing course or modifying goals midstream will receive heightened scrutiny from investors and the proxy advisory firms. A well-designed ESG goal should reward the achievement of a realistic, meaningful objective in a manner that is readily comprehensible by company constituents.

Proxy Advisors and Institutional Investors. Neither ISS nor Glass Lewis issued any significant compensation-related policy updates for the 2022 proxy season. Of course, while ISS and Glass Lewis recommendations have the most significant impact on outcomes, many institutional investors maintain their own voting guidelines on compensation matters. Understanding the guidelines of a company’s largest institutional investors is essential. Blackrock is a bellwether for policy trends. Among other policy pronouncements, Blackrock’s 2022 voting guidelines provide that “[d]uring a period in which executive compensation appears excessive relative to the performance of the company and compensation paid by peers, we may vote against the members of the compensation committee.” Note that the Blackrock policy could result in an immediate vote against both a company’s say-on-pay proposal and members of its compensation committee, rather than the more forgiving ISS escalation approach.

SEC Guidance on “Spring-Loaded” Compensation Awards. Late last year, the SEC issued accounting guidance on “spring-loaded” compensation awards, which the Commission defines as share-based compensation that is granted before the announcement of market-moving information. According to the Staff Accounting Bulletin, as companies measure compensation actually paid to executives, they must consider the impact that the material nonpublic information will have upon release. This interpretation would increase the accounting expense for award grants in scenarios in which a company’s stock price rises after the award grant date as a result of the subsequent disclosure of material nonpublic information. While the Commission’s guidance is well-intended, it runs the risk of penalizing companies for coincidental timing. We hope that the Commission will be judicious in limiting any enforcement activity to cases of abuse or clear negligence. In the meantime, companies should ensure adequate internal controls and policies to minimize the risk of a potential spring-loading issue.

Perk Disclosure. SEC inquiries and enforcement actions relating to inadequate perquisite disclosure continued in 2022. These actions assert violations of the proxy disclosure rules and do not require proof of intent. Settlements in this area include financial penalties, remedial action such as engaging outside advisers to review and revise policies and seeking repayment from the executives. It is important to maintain internal controls to track and properly report items that could be perquisites within the meaning of Item 402 of Reg S-K.

Dodd-Frank Act Regulations. Last October the SEC reopened the comment period for the compensation clawback policy rules first proposed in July 2015, suggesting that final rules may be forthcoming in early 2022. Now is a good time to take stock of existing clawback policies in order to ensure alignment with any new SEC requirements once the Commission promulgates final rules. We continue to await final regulations regarding disclosure of pay for performance.

Front-Loaded Equity Grants. Companies periodically grant equity awards that cover multiple grant cycles in lieu of issuing new awards each fiscal year. While Tesla’s option grants to Elon Musk are the most prominent example of this type of award, front-loaded awards are more often structured as performance-based restricted stock units. Front-loaded grants highlight a number of considerations regarding equity award grant practices:

Review Equity Plan Limits. Always confirm that a grant complies with individual or aggregate share limits and does not otherwise run afoul of applicable plan terms.

Process Matters. Provide the compensation committee with the information it needs to consider and approve the grant on a fully informed basis, including a written summary of the material terms of the award, award cost, benchmark data and draft versions of applicable SEC disclosure. Additional care should be taken in potential conflict situations, e.g., where the award recipient is also a significant stockholder.

Manage the Rollout. Anticipate the reaction of the proxy advisory firms and large institutional investors. ISS is likely to issue a negative say-on-pay recommendation, especially where the award results in a significant year-over-year increase in reported compensation.

Understand HSR Filing Requirements. The receipt of certain types of awards having a value above applicable thresholds will trigger an immediate filing obligation under the Hart- Scott-Rodino Antitrust Improvements Act of 1976. Failure to comply may result in significant fines.

While multi-year grants may present challenges, those challenges are not insurmountable, and such grants may be an effective way to retain key leaders over a longer time horizon.

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