Prepared Remarks for the SEC Roundtable on Executive Compensation Disclosure Requirements

A big thanks to the SEC. Thanks to everyone participating, either here or on the stream.

Thanks for inviting me and my institution, the Norwegian Fund [1], which reaps the benefits of investing in America. The majority of our global portfolio we invest here in America.

As a shareholder and investor, we are increasingly getting involved in discussions on executive compensation. Here are five points I would like to make.

1) One of the things we love in America is stock ownership by CEOs. We like it especially when that ownership is long term and irrevocable.

2) However, the freedom for companies to pay in such simple, long-dated shares has become curtailed over the last 20 years. It has become almost a market norm that the majority of equity-based pay should be in much more complex performance share units.

3) Another concern is that companies that are locking in incentive shares to the CEO for longer than the usual 3 years don’t get the credit they deserve, but doing so is what many long-term investors want.

4) Executive compensation has gotten so complex and intricate that we should discuss whether ‘say on pay’ really works in its current form.

5) Therefore, a key question today is whether an update to the SEC disclosure rules can help us out of this suboptimal situation.

We can come back to all of that, but I wanted to provide you with a flavor of why we get involved – in the individual companies where we invest, as well as in the discussion on overall market framework which is the topic today.

1. Long-term alignment of the CEO via simple stock grants

As a shareholder, we love long-term stock ownership by the CEO. That ownership should be long-term, and it should not be disturbed by conditions.

The benefits of CEO ownership is solidly proven in academic evidence.

The emphasis on equity-based pay for CEOs is therefore a great feature of US corporate governance

In our perspective, simple restricted shares is a far better model than the complexities resulting from ‘performance share units’

2. A curtailed freedom for companies to pay in simple shares

The opportunity to pay in simple restricted shares has been curtailed by almost a market norm calling for PSUs to be the majority of equity-based pay

Over the last 20 years, we have seen a massive shift in incentive vehicles – from options and simple stock grants to PSUs.

The proxy advisors are necessary and helpful for us as a globally diversified equity investor, but on this issue we strongly disagree with their policies.

They are much more likely to recommend votes against pay if PSUs are not the majority of equity grants. We can discuss why this is so, but the effect is a strong encouragement for companies to choose relatively complex and opaque PSUs rather than simple time-restricted stock.

Our preference is for simple stock grants with a lock-in period through the business cycle as determined by the board of directors. We exemplify that with 5-10 years in our position paper on CEO compensation.

We have no issue with competition for talent. But we think substantial pay should be counterbalanced by a commitment to keep much of those dollars invested in the stock through the business cycle. We would like the lock-in to stay when the CEO steps down.

‘Performance based’ sounds better than ‘time-based’. Many people’s intuition would be that incentivizing on 3-year performance criteria gives better performance.  But the world is a difficult place and setting these criteria in ways that are future proof and don’t risk suboptimization – it’s easier said than done.

Unfortunately, there is evidence in academic literature that complex and opaque incentive criteria invite myopia and lead to suboptimization. Fortunately, there is also evidence that stock ownership by the CEO is positively correlated with stock performance.

3. Lack of credit to companies locking in CEO shares longer than usual

While many of us here in the room might believe that vesting generally takes place over a 1-3 year schedule, in our (US) portfolio, 465 companies have vesting over 4 years, and 83 over 5 years or more [2]. Other companies combine a vesting schedule with a subsequent mandatory holding period.

These companies that are stretching the mandatory commitment to the stock don’t get the credit they deserve. This lock-in historically has not helped them very much with the proxy advisors, and hence investors may not even notice.

4. ‘Say on pay’

Proxies are too long and complex. Most investors are not able to digest this information. The compensation section of the proxy statement can make up 40-70 pages with lots of tables, but still some key information missing. It is really hard, sometimes even impossible, to follow the life of a PSU grant through the successive proxy statements where it is included.

Because of this complexity, investors therefore often resort to box ticking rather than analysis, when deciding how to vote.

One of those boxes, suggested by proxy advisors, is whether grants are predominantly PSUs.

This is how PSUs could become the market norm, without any academic evidence that it works. The limited evidence that is out there indicates that stock returns are better without performance share units. This is also what we find in our data.

5. Updated disclosure

A key question today is whether improved SEC disclosure rules can help getting us out of this suboptimal situation? Here are 6 questions suggesting ways to think about this.

a. Could one simplify reporting requirements for those companies choosing super-easy, long term equity grants as their way of incentivizing the CEO?

b. Could one mandate disclosure on whether equity-based pay will actually settle in stock and not in cash? Some investors probably believe that stock grants settle in stock when they actually settle in cash. Being investors, we prefer settlement in equity.

c. Could one tweak disclosure formats so that it gets very easy to follow each award through its entire life from grant to vesting and release?

d. For PSUs, could one require a detailed break-down of the award into each of the tranches corresponding to performance criteria and show how those were assessed at vesting? Today, there is much focus on criteria for future vesting, but very little focus on how those criteria were treated at vesting. For instance, each grant and tranche could be shown in a Gantt chart style diagram? This would show through time each existing stock grant vintage, complete with breakdown into each separate vesting criteria, milestones, weights and ultimate vesting outcomes. It could include any one-time awards. With annual bonuses and their criteria on top of that Gantt chart, investors could see for themselves how all the overlapping vintages of grants and bonuses add up to an incentive bouquet, sometimes a crowded one. In comparison, just annual bonus and a long-term incentive plan using simple stock grants will look much tidier.

e. For PSUs, could one require comprehensive reconciliation for all non-GAAP figures including adjusted numbers? This could include ex-ante adjustment rules as well as ex-post reconciliation against GAAP numbers.