This spring, as usual, most pay-related resolutions in proxy statements will be from corporations seeking shareholder approval of pay packages for named executives. But not all the pay votes will implement this now-familiar “say on pay,” where shareholders look back at the past year’s compensation plan to give thumbs up or down. More shareholders will be proposing their own pay concepts for a vote this season—and many of these proposals will reflect shareholder’s growing interest in social issues.
Who Needs Dodd-Frank?
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Directors in 2017 may see a new kind of resolution meant to re-assert any Dodd-Frank pay rules that get stalled or repealed this year. As reported in detail in the January/February 2017 issue of NACD Directorship magazine, President Trump may use executive orders to delay or undo Dodd-Frank, and Congress may revive a number of bills to repeal Dodd-Frank, including the parts of the law focused on executive pay. As expected, the president on February 3 issued an executive order outlining core principles that should guide the rollback of Dodd-Frank era regulations. As a result of this potential pullback on pay rule-making, companies may see shareholder resolutions mandating what those rules would have imposed, e.g., mandates for stricter executive pay clawbacks or for pay-versus-performance and pay-ratio disclosures.
Not surprisingly, directors and shareholders have been talking face-to-face about pay in preparation for this season. The 2016–2017 NACD Public Company Governance Survey reveals some interesting trends. In 2016, 48 percent of respondents indicated that a representative of their board had held a meeting with institutional investors over the past 12 months, compared to 41 percent in 2015. The most common discussion topics at those meetings were executive pay and CEO performance metrics and goals. Another common topic was “specific shareholder proposals,” which no doubt included the range of causes noted in our recent post predicting a rise in socially-minded proxy resolutions.
For many companies, measurement of performance includes social goals. In 2016, 80 percent of respondents to the NACD survey indicated that they consider non-financial metrics when evaluating executive performance to determine executive compensation. The metrics they use include, in descending order from 37 percent to 8 percent, the following:
Maintaining good standing with regulators;
Sustainability-related measures, and;
Many of these performance metrics could be considered “social” aspects of pay.
Executive Pay Proposals at Apple, Walgreens Boots Alliance
The 2017 proxy at Walgreens Boots Alliance (WBA) reveals that Clean Yield Asset Management proposed that WBA issue a report linking sustainability metrics to executive pay. The proposal asks the board compensation committee to prepare a report “assessing the feasibility of integrating sustainability metrics into the performance measures of senior executives,” and defines sustainability as “how environmental and social considerations, and related financial impacts, are integrated into corporate strategy over the long term.” The company recommends a vote against this proposal, highlighting its achievements in the field of sustainability, and concluding that preparing this report would not be a productive use of company resources.
On another note, Apple’s 2017 proxy statement contains two shareholder resolutions on pay—one focusing on increasing the requirements for stock ownership, and one that takes a more social turn. In proposal 8, shareholder activist Jing Zhao brings into the current season an economic concern voiced by a significant number of shareholders across several companies in 2016, when the 250 largest companies saw 38 shareholder-sponsored proposals on pay. While the subjects of these proposals varied, most of the 2016 proposals alluded, in one way or the other, to compensation practice reform.
Zhao’s current resolution proposes the following: “Resolved: Shareholders recommend that Apple Inc. engage multiple outside independent experts or resources from the general public to reform its executive compensation principles and practices.”
In summary, Zhao’s proposal takes aim at the identical nature of the senior executive pay below the CEO, and questions the need of a compensation consultant given such conformity. But the supporting details reveal that the proposal is not really about how many advisors Apple engages. Rather, it is about income inequality. Zhao’s commentary goes on to address the larger picture of societal well-being. He quotes Thomas Piketty, arguing that income inequality “has contributed to the nation’s financial instability,” and tracing this inequality to “the emergence of extremely high remunerations at the summit of the wage hierarchy.” (Capital in the Twenty-First Century, Harvard University Press, 2014, pp. 297-298, reviewed here in NACD Directorship).
The response from Apple management addresses the proposal itself rather than the surrounding complaint. Apple’s executive officers “are expected to operate as a high-performing team; and we believe that generally awarding the same base salary, annual cash incentive, and long-term equity awards to each of our executive officers, other than the CEO, successfully supports this goal.”
The Sleeper Issue: Director Pay
The sleeper issue this year may be director pay. The 2015-2016 Director Compensation Report, authored by Pearl Meyer and published by NACD, showed only a modest rise in director pay, and predicted the same for 2017. Nonetheless, director pay is becoming a hot issue for shareholders.
Consider the new guidelines from the leading proxy advisory firm, Institutional Shareholder Services (ISS), which serves some 60 percent of the proxy advisory market. Proxy voting guidelines of ISS and Glass, Lewis & Co. contain updates to discourage perceived director overboarding—and compensation does not follow far behind. It is notable that ISS amended its proxy voting guidelines, effective February 1, 2017, to include director pay. The ISS voting changes also include changes to ISS policies on equity-based pay and other incentives, as well as amendments to cash and equity plans, such as mandatory shareholder approval for tax deductibility. But the most unexpected development was ISS’ support for “shareholder ratification of director pay programs and equity plans for non-employee directors.”
ISS says that if the equity plan is on the ballot under which non-employee director grants are made, ISS policy would assess the following qualitative factors:
The relative magnitude of director compensation as compared to similar companies;
The presence of problematic pay practices relating to director compensation;
Director stock ownership guidelines and holding requirements;
Equity award vesting schedule;
The mix of cash and equity-based compensation;
Meaningful limits on director compensation;
The availability of retirement benefits or perquisites, and;
The quality of disclosure surrounding director compensation.
These values are not new. NACD went on record supporting such concepts in our Report of the NACD Blue Ribbon Commission on Director Compensation, issued in 1995. Every year since then we have issued an annual survey on director compensation with Pearl Meyer (cited above), reinforcing these key points.
In explaining the rationale for its policy update, ISS notes that there have been several recent lawsuits regarding excessive non-employee director (NED) compensation. For a summary of these lawsuits, see the Pearl Meyer/NACD director compensation report cited above.
ISS notes activity behind the scenes re director pay. According to the proxy vote advisor, “some companies have put forth advisory proposals seeking shareholder ratification of their NED pay programs,” and further, “ISS evaluated several director pay proposals during the 2016 proxy season, and we expect to see more submitted to a shareholder vote.”
Say on Pay for Directors?
Given the new interest in director pay, might it become subject to “say on pay” in the U.S.? Such a mandate has already begun overseas. Since 2013, Switzerland has had an “Ordinance against Excessive Compensation with Respect to Listed Companies.” The law mandates annual shareholder votes on the total pay awarded in any form by the company to its directors and, in a separate vote, to its senior executives. The pay period can be retrospective (last year) or prospective (next year). So far, after an initial wildensprung of rebellion against some boards, approval ratings have been very high. The 2017 proxy season may continue this trend—or contain surprises. Given volatility in the global economy, and in shareholder sentiment, it is wise to avoid complacency.
Because board members set their own pay, director compensation is a wide-open opportunity for shareholder litigation. In this BoardVision interview–moderated by NACD’s Publisher and Director of Partner Relations Christopher Y. Clark—Marty Coyne, experienced director and chair of NACD’s New Jersey chapter, and Dan Laddin, partner at Compensation Advisory Partners, discuss ways boards can limit exposure to litigation when it comes to director compensation:
Both the compensation committee and the governance committee are involved in determining director pay.
Director compensation aligns with that of company peers.
Director compensation is based on the responsibility of directors—which may see little change from small to large companies.
Companies may consider adopting a shareholder-approved limit for director compensation.
Here are some highlights from the discussion.
Christopher Y. Clark: Do you think that the [nominating and governance] committee or the compensation committee should [have primary responsibility for setting director pay]?
Dan Laddin: Chris, if we look at the market, it’s pretty mixed—a little bit leaning towards [the] compensation committee versus [the] nom/gov [committee]. At the end of the day, I think it really comes down to the principles you use for compensation of your directors overall. One, you may want to make sure you have an objective committee, which obviously you would [with]…either. You also want to make sure that compensation for directors aligns with the philosophy of the directors, and so in that sense, maybe the compensation committee is a little closer to that. At the end of the day, there’s a lot of cross-pollination usually across those two committees, so either works fairly well. We do see a little bit [of] leaning towards the comp committee though.
Clark: Thanks, Dan. Marty, you’ve been on all types of boards. What is your take?
Marty Coyne: I prefer the compensation committee…mainly because the comp committee is much more familiar dealing with the compensation consultant and much more familiar with the peer group. And so when you look at all of the data inputs, the comp committee understands the source, where the weaknesses are, and the strengths. I think one of the key things, though, is the full board approves director compensation. So regardless of which committee brings it forth, and brings forth the recommendation, the full board has to vet it and approve it.
Clark: In many cases, for leading governance practices, company size does matter. [Companies] are affected by different policies and regulations. The boards are occasionally very different; occasionally they are not. But when it comes to director compensation, it is a hot button and it certainly affects that board’s reputation [and] the company’s reputation, but most importantly, that individual director’s reputation. So, Dan, again, let me start with you. Do you feel that there is a company size factor here when it comes to compensation and reputation?
Laddin: I think reputation risk exists regardless of the size of the company, and that’s somewhat borne out by the compensation data we would take a look at. … [T]here’s a basic responsibility of directors that doesn’t really change, regardless of company size, and that’s really reflected in the compensation data.
Coyne: There is a scale that the bigger the company [is], the more the directors are paid. The exposure potential for larger-company directors is far greater than the smaller-company directors because they just make better news than the smaller companies. There is a point though; it’s almost like a minimum size where, when you hit it,…the director workload is pretty much the same regardless of the size of the company. And, to attract and retain good directors, you’ve got to pay a fair compensation for those individuals.
Clark: Many companies have director compensation limits. My question would be why, and what is a fair compensation limit?
Laddin: Sure. So this concept of the limits really [has been] coming to play in the last few years, as there were a few lawsuits against companies that said directors are inherently conflicted when they are setting their own pay. And in those specific companies, the view was that they set it well above any credible norm… The attorneys came in and said, “We can basically put in a shareholder-approved limit on directors’ compensation,” which then gets us back within this business judgment rule.
Clark: For the shareholder-approved limit, what’s the status today?
Laddin: We’re seeing most companies, as they go back to shareholders to renew their plans in the normal course, that that’s when they go back and put in a limit. When they go back for new equity plans or just general approval from shareholders, that’s when it’s happening. I wouldn’t say there’s a mad rush to do it, but it is normal course.
Clark: Well, Marty, what has been your experience? You’ve been on public boards, [and] you’ve been on private boards.
Coyne: I think…having a limit is very, very valid—and it’s necessary. I don’t see any resistance to putting limits on directors’ compensation. If I were a shareholder, I would expect my compensation plan that I’m approving to have limitations for director compensation.
Clark: When we look at the umbrella of business judgment and compensation, I’ve got to ask you, is the litigation environment lukewarm or is it red hot?
Laddin: I would say it’s lukewarm at this point. The lawsuits have really been at the extremes where director compensation was well above the norm.
Coyne: I think…there’s been a quantum step forward on the nom/gov side in choosing the right directors sitting around the table. I think the next step is going to be how do you compensate your directors? What is your philosophy to attract and retain good directors? How does director compensation correlate with company performance? Is there potential pay at risk? I think there will be some…comparisons of director comp to the TSR. And if a company is not performing well, I think directors are going to have to answer a lot of tough questions about why are we paying you when the company performance is so poor? But I don’t see any dramatic changes in the next couple of years.
Litigation challenging director pay has made headlines over the past 18 months with shareholders alleging that pay is excessive pay or challenging the processes by which pay is set. The reality is, however, that a new norm of modest pay growth has settled in across American boardrooms, according to the Pearl Meyer/NACD 2015–2016 Director Compensation Report.
Elements of Board Pay Remain Steady
The report, co-produced by NACD and the executive compensation consulting firm Pearl Meyer, reveals that over the past five years, median director pay increased annually at a rate of 3 percent to 5 percent per company, while year-over-year pay increased between 1 percent to 5 percent. This steady but incremental trend is attributable to the typical board practice of only suggesting changes in pay every two to three years. Low- to mid-single-digit pay increases are expected to continue for the next several years unless a significant catalyst for change occurs.
In 2015, the numbers rose slightly from the average, save for micro companies, whose directors saw a compensation increase of 9 percent. Pearl Meyer attributes this jump to minor changes occurring in the constituent companies that are surveyed year over year, and to their volatility as high-growth oriented enterprises that quickly exceed the $500 million mark.
Jannice L. Koors, managing director at Pearl Meyer and head of the firm’s Chicago office, noted that pay practices appear to be reverting to those seen prior to the passage of the Sarbanes-Oxley Act of 2002 (SOX). “The pendulum is swinging back to director compensation in the pre–SOX days, when pretty much all director staff was paid the same,” she said. The concept underscores the board’s unity when, in Koors’ words, “something goes bump in the night.” “If all the board members’ feet are going to be equally held to the fire, then is it really appropriate to have differentiation in how the committee members were paid for that liability risk?” she asked.
Use of Cash Retainers Increases, While Pay for Committee Members Is Limited
Another element that has demonstrated statistical prevalence is the rate of cash retainers for directors across companies. Ninety-seven percent of companies offer cash retainers to their boards as compensation for their service. The cash retainer typically makes up 32 percent to 36 percent of total director compensation (TDC) packages. Equity grants also continue to comprise a large portion of a director’s pay package—93 percent of companies offered grants. Companies of all sizes offered equity grants at a fixed dollar value rather than a fixed number of shares. This practice is perceived to better align directors’ stewardship and oversight responsibilities. When these fixed-value equity awards are included in TDC, the number of shares is typically adjusted to each grant date based on the price of the stock to provide an equivalent value each year.
One standout figure in this year’s data emerged in the differentiation of compensation by committee role. Audit committee chairs received the highest level of compensation across company types at a median level of $20,000, with compensation and governance committee chairs receiving progressively less, at $15,000 and $10,000, respectively.
A similar trend is reflected in the median total compensation figures for all committee members, which includes both retainers and meeting fees. However, the prevalence of compensation for committee members decreases with the size of the company. Members of both the compensation and the nominating and governance committees at Top 200 companies—the largest 200 companies in the S&P 500 by revenue—are not compensated at more than half of the companies surveyed, which results in median compensation of zero dollars for these committees when averaged with those that do provide retainer or meeting fees for committee service.
“I don’t know that I would ever see the trends moving to a place where committee compensation goes away across the board for all companies in all situations, because there are some very legitimate reasons where committee pay actually makes sense and plays a role where the workload isn’t even,” Koors said.
Legal Implications Regarding Pay
Three recent court cases that have either been adjudicated or are in process open the door to potentially significant changes in director pay practices.
In an ongoing case being heard in the Delaware Court of Chancery, shareholders of Citrix Systems have accused directors of awarding themselves excessive equity compensation in a pay plan that was ratified by shareholders in 2005. Shareholders claim that directors failed to accurately and fully disclose several details during the process, specifically the amount or form of compensation to be rewarded to the non-employee directors. Additionally, shareholders allege that only five of the 14 peers selected for comparison in the ratified pay policy were true industry peers.
Directors argued the stockholder ratification defense when seeking to have their case heard under the business judgment rule. The court ruled, however, that the ratified Citrix payment plan was indeed not specific enough, hence disqualifying the Citrix board’s case from being heard under the more deferential business judgment standard.
A case against Goldman Sachs, brought by shareholders before the Delaware Court of Chancery in June, alleged that directors bear the burden of proving the entire fairness of a per-participant limit of 24.75 million shares, which was valued at $2.8 billion when the case was filed. While the same might not be true for Citrix, it appears as though Goldman Sachs based its compensation on a true peer group. A decision is pending.
At Facebook, Chair and CEO Mark Zuckerberg and the board came under fire in 2014 for the process used to ratify director pay. That case, which went to trial under the entire fairness standard, argued that Zuckerberg’s deposition and affidavit of approval of the director compensation plan put forth by his board was not valid, as Zuckerberg was acting for the directors as an interested party and violated the rule that such transactions must be approved by a vote at a stockholders meeting or by written consent. Facebook settled in late January after Zuckerberg’s ratification was deemed invalid by the Delaware Chancery Court, and the social media company agreed to stricter oversight of director compensation.
Koors suggests that all boards take the time to ensure their disclosures accurately and clearly reflect the rationale of the director compensation program, with full highlights of their skills, qualifications, demographic diversity, and details on the nomination and board re-evaluation processes. More robust communication regarding director selection and compensation could help mitigate proxy season disruption, as well as protect against the types of litigation described.
Pearl Meyer’s 17th annual survey of non-employee director compensation examines key director compensation elements as collected from 1,400 companies across 24 industries, and derives its findings from proxy and other financial statements that disclose director compensation information for the fiscal year ending between Feb. 1, 2014, and Jan. 21, 2015. Companies were assigned to one of the 24 industries based on their industry classification within Standard & Poor’s Global Industry Classification Standard (GICS). Data for the survey was collected in part by Equilar Inc. Comparisons are made to the Pearl Meyer/NACD 2014–2015 Director Compensation Report. All companies surveyed are publicly traded.
This blog is excerpted from an article originally published in NACD Directorship magazine’s March/April 2016 issue.