CD&A Planning for Proxy Statement Disclosure of Exec Comp
2016 Be Smart about CD&A Presentations
Over the past several years, public companies have seen their proxy statement disclosure of executive compensation evolve from an exercise in thoroughness to a challenge about how best to convince shareholders that sound decisions effectuate a pay-for-performance regimen. The highest premiums attach to (1) starting with effective summaries, (2) including visual support, and (3) being proactive to defuse red flag items within the summary compensation table.
Provided below, in roughly descending order of priority, are the following guidelines that corporate directors and officers should consider when addressing executive compensation disclosures for shareholder meetings in 2016:
| Considerations Discussed Below|
1. General Advice about CD&A Prep
| 2. Pay for Performance - be convincing|
| 3. Red Flags and Bad Practices - be watchful for irritants|
4. Improvements and Successes - be sure to highlight
| 5. Prior Year's Say on Pay Vote|
| 6. Shareholder Engagement |
| 7. Peer Group Selection and Consultants|
| 8. Track Trends and Litigation Risks|
| 9. Consider Sample Proxy Statements|
1. General Checklists and Advice -- see Best Practices Checklist
- See pages 52-77 of E&Y's CD&A Content Checklist (updated Nov. 2015). This 10-page report lists CD&A content requirements in one column, with "qualitative guidelines" being presented in an opposite column. Towers Watson has aptly described its "Scorecard" as an aid for compensation committees.
- "Candor for Compensation Committees." This article from Board Member magazine provides solid advice for directors, and concludes with a warning that is apropos now as when first published: "Directors need to take ownership over executive compensation, from articulating a well-considered philosophy to selecting insightful advisers, to making sound executive compensation decisions and convincing public disclosures."
2. Lead with Pay for Performance ("P4P")-- "No Longer a Punchline" (per Wall St Journal article, 3/20/2013)
- 2014.Nov ISS Releases Revised Pay-for-Performance Approach Memo. ISS has revised its publication titled "Evaluating Pay for Performance Alignment: ISS' Quantitative and Qualitative Approach." The introduction to the publication explains that "Investor feedback on the issue of pay-for-performance has indicated a preference for putting the focus on long-term alignment, board decision-making, and pay relative both to market peers and to absolute shareholder returns. As a result, ISS’ approach to evaluating pay-for-performance comprises an initial quantitative assessment and, as appropriate, an in-depth qualitative review to determine either the likely cause of a perceived long-term disconnect between pay and performance, or factors that mitigate the initial assessment."
- The Danger: Several "no" votes have arisen from poor P4P correlations, with a high percentage of the unfavorable recommendations from ISS being rooted in failure of its stock performance test, based on one-year and three-year total shareholder returns).
- Action Items:
- Improve Bonus Plan, long0term incentive, and equity plan disclosures - in each case to demonstrate that award levels reflect P4P considerations.
- Consider including visual aids in the form of charts and graphs (for example) to justify executive compensation. See demonstrating pay-for-performance.
- Disclose "Realizable Pay"? Over the past year, "realizable pay" has gone from being a possible supplemental disclosure to being widely reported – not as part of the compensation tables but as a core element in CD&As. Here is what Institutional Shareholder Services (ISS) reiterated in its Nov. 2014 P4P guidelines: “Based on feedback from investors and issuers, beginning in proxy season 2013, ISS is incorporating a defined calculation of "realizable pay" more systematically into the qualitative review of S&P 500 companies.” For a good sample disclosure, see the 3/21/2013 proxy statement released by Unisys – available here. Overall, inclusion of a realizable pay disclosure makes sense, with the key being to make an effective disclosure and discussion.
3. Avoid Irritants (i.e. Defuse Red Flags)
- Problematic Practices: be sure to avoid or to justify any of the practices that ISS or other proxy advisory single out for scrutiny. See this ISS Problematic Practice Checklist.
- Perquisites, Tax Gross-ups, Single Triggers for Severance, SERPs -- These are the headline items that are sure to catch the attention of shareholders and proxy advisors.
- Extraordinary Amounts . . . disclosed in the Summary Compensation Table are a common trigger for "no" votes. For example:
- Sign-on Bonuses and Exit Incentives.
- 2012.July.15 See Medtronics 14A.
- Year-over-year Increases.
- 2012.Mar.9 Int'l Game Tech received the first failed say on pay vote for 2012, perhaps because (1) its summary comp. table showed that its CEO and CFO received a 60% increase in year-over-year total compensation, and (2) the executive summary in its CD&A merely explained that "This grant was deemed essential to promote the longer-term retention of critical senior leadership".
- Global Perspective - Keep an eye out for global developments because they are often leading indicators for U.S. developments.
- 2011.Sept.22 Mercer Alert, observing that "Although the historical context that gave rise to say on pay has varied by country, the outcome of say on pay has followed a common path: generally greater company awareness of hot-button compensation issues and more engagement and transparent communication with shareholders."
- Hedging and Pledging - ISS and Glass Lewis have highlighted governance concerns that could arise from efforts by executives to pledge or to hedge their risk exposure from employer stock investments, with the SEC releasing its proposed hedging disclosure regulations on February 9, 2015. See this Alert for further 2015 information. In its 2013 policy update (page 4), ISS highlighted the hedging and pledging of issuer securities as a factor relevant when considering its voting recommendations for directors, committees, or entire boards. See Hedging and Pledging Disclosures.
4. Highlight Improvements and Accomplishments
- Bulleted Lists:
- 2013.Jan.10 Checklist of best practices reproduced from proxy statement for Headwaters, Inc.
- See Qualcomm's 14A filed 1/19/2012, pages 27-28, for an illustration of the proactive use of a bulleted list to highlight the company's best executive compensation policies and practices.
- Narrative of Positive Actions:
- See Varian Medical's year-end 2010 proxy statement for a list of 12 positive actions taken by its Comp Committee over a multi-year period. That disclosure could have been even better had it included a few more specifics, such as more about the new performance metrics.
- See Sample 14As re Prior Year Say on Pay Vote and Company Actions.
5. Address Prior Year's Say-on-Pay Vote
- Expect Voting Volatility. Compensation committees should expect volatility, especially from shareholder reactions to pay-for-performance disconnects or "irritant" practices (including conspicuous awards that are not convincingly justified). Recent years have showed the false sense of security that can come from presuming that past favorable votes will provide continuing cover. Boards should beware of the trend-lines in their say on pay voting results, and should immediately take decisive action to reverse declines.
- For issuers who received solidly favorable votes in the prior year (generally 90% or more), see the following examples of how to highlight the favorable vote and continuation of past practices.
- Johnson & Johnson (2012.Mar.14) -- generally innovative in presentations, especially re response to 62% favorable vote in 2010, which was acknowledged as "disappointing" and which prompted responses on many levels.
- Agilent Tech (14A filed 2012.02).
- QuikSilver (14A filed 2012.02).
- For issuers who received less solid shareholder support (especially if less than 70% favorable because that triggers heightened ISS scrutiny), the best strategy generally entails starting the CD&A with a discussion that covers the following points:
- How pay correlated to performance -- see discussion above.
- What improvements occurred in the prior year -- see discussion above.
- Why any extraordinary pay components are justifiable (e.g. a mega-grant of stock options, SERP benefit, or tax gross-up).
- Shareholder Engagement - see Johnson Controls' 14A for 2013.
- See Sample 14As re Prior Year Say on Pay Vote and Company Actions.
6. Peer Group Selection/Consultants
- Because ISS and other proxy advisors are focusing on which peer groups are most appropriate, and justifiable, for purposes of making pay-for-performance comparisons, be attentive to documenting the role and independence of compensation consultants and advisors, to anticipate new NYSE and Nasdaq Rules -- see Alert.
- Peer Group Selection (generally)
- Compensation Consultant Independence - see CLARECOR 14A (2/17/2013, page 17).
7. Shareholder Engagement
- Discussion of Engagement
- 2013.Mar.26 Dun & Bradstreet's Proxy Statement -- see page 26 re Say on Pay Proposal (No. 3).
- Early Engagement -- Reaching out to major shareholders is not only smart (in order to alert an issuer to the reason for unfavorable votes) but is also warranted in order to position the issuer to make its required disclosure about actions taken in response to the preceding say on pay vote (see rules and sample disclosures).
- Rapid Response Plans -- Issuers should prepare in advance for unfavorable vote recommendations from Glass Lewis or ISS, as well as (1) unfavorable votes from major shareholders, and (2) injunctions that agitating shareholders seek in order to delay annual meetings, with the argument being that the proxy statement omits material information needed either for say on pay voting or for approval of a proposed stock plan. Additional soliciting materials and/or direct outreach will need to be pursued promptly; advance designation of a team will expedite this.
8. Track Trends and Litigation
- Board members should receive regular information about executive compensation developments relating to the following topics that could warrant prompt attention in order to defuse risks of litigation or adverse shareholder reactions.
- the reason for unfavorable say on pay votes -- see unfavorable votes 2011 and 2012.
- the claims asserted in say on pay litigation (noting that in 2011-2012, almost 20% of the boards of companies that received unfavorable say on pay votes were sued for breaching fiduciary duties and other related claims, e.g. corporate waste).
- other shareholder derivative litigation aimed at issuers and their directors re executive compensation -- see litigation against boards.
9. Consider Sample Proxy Statement Disclosures