Executive Compensation

Stock Buybacks: Trouble in Paradise?

This week, the new Democrat SEC Commissioner, Robert J. Jackson, Jr., gave a speech in which he presented the findings of his staff’s research into how “buybacks  affect how much skin executives keep in the game.” Commissioner Jackson was a law professor who liked to conduct research before joining the SEC. Commissioner Jackson said that he often asked his students two questions when thinking about how to give corporate managers incentives to create sustainable long-term value:

  • Are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities?
  • Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?

Commissioner Jackson noted that the theory behind paying executives in stock is to give them incentives to create long-term sustainable value. But, as he also pointed out, that only works when executives are required to hold the stock over the long term.

So when the Tax Cuts and Job Act was signed into law, Commissioner Jackson worried that we would see a repeat of what corporations did when the last corporate tax holiday was enacted in 2004–use the cash influx for stock buybacks and not necessarily  invest in long-term value creation. The first quarter of 2018 saw corporations buyback $178 billion in stock. So Commissioner Jackson and his staff studied 385 buybacks over the last 15 months and matched them to information on executive stock sales. They found:

  • A buyback announcement leads to a big jump in stock price–typically more than 2.5% during the 30-days after the announcement;
  • In half the buybacks studied, at least one executive sold shares in the month following the buyback announcement.
  • In the days before a buyback announcement, executives trade in relatively small amounts (less than $100,000 worth daily), but during the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day.

Commissioner Jackson did acknowledge that this stock trading by executives is not necessarily illegal. However, he finds it troubling as he see it as more evidence that executives are spending more time on short-term stock trading than long-term value creation.

Commissioner Jackson pointed out that, “Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”

Commissioner Jackson then called for the SEC to update its rules to limit executives from using stock buybacks to cash out from America’s companies. He also called for an open comment period to reexamine the SEC’s rules in this area to make sure they protect employees, investors, and communities given today’s unprecedented volume of buybacks.

Implications

At the very least, any company that has undertaken a stock buyback during the past 1 to 2 years, should know how their executives traded stock shortly after the announcement of their buyback. Companies should know which executives made these stock sales and the rationale for the sales. Companies should be prepared to answer questions about such transactions from their investors and the media. It also might be a good idea to review whether peers undertook stock buybacks during the past 1-2 years and how much stock was sold by their executives shortly after their buybacks were announced. Companies should review this data and know how they compare to their peers, and, if relevant, larger market players. Companies contemplating adopting a stock buyback should consider this emerging view as an additional point in their deliberations.

Executives should ensure that they are utilizing a Rule 10b5-1 stock trading plan, and have established such a plan when they do not have any material non-public information (such as the fact that the company is considering adopting a stock buyback plan). While a Rule 10b5-1 plan does not offer full protection to executives, it is the best currently available to protect them from allegations of illegal stock trading, assuming the plan is set up as required by the rule. If stock sales were made after a buyback announcement that did not utilize a Rule 10b5-1 plan, executives should ensure that all preclearance procedures were followed. To the extent that stock sales increased after a buyback announcement, executives should review the reason for such action and be prepared to discuss with their Boards or internal compliance officer.

Link to SEC Commissioner Jackson’s Speech

https://www.sec.gov/news/speech/speech-jackson-061118

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ISS Posts Final FAQs and Other Policy Document for 2018

On December 14, 2017, ISS issued several important updated documents concerning its policies and methodologies for the upcoming 2018 proxy season:

These are all available on ISS’s Latest Voting Policies: 2018 webpage on its website: https://www.issgovernance.com/policy-gateway/latest-policies/

This page also includes information ISS released on its European Pay-for-Performance Alignment and Methodology.

U.S. Compensation Policies: FAQs

This supersedes the preliminary FAQs on this topic issued in November 2017.  These FAQs make changes to or introduce ISS policies:

  • How ISS Assesses Board’s Actions Taken in Response to Low Support (<70%) on a Say-on-Pay (SOP) Vote
    • Same as last year’s policy except now ISS will expect companies to address in their proxy statements: (1) the breadth of the engagement with shareholders, including the frequency and timing of engagements, number of institutional investors and the company participants including whether independent directors participated as well; (2) disclosure of specific feedback received from investors; and, (3) specific and meaningful actions taken to address shareholder concerns.
  • Lay out the four measures now used in ISS’ quantitative Pay-for-Performance (P4P) screen
    • Relative Degree of Alignment (RDA) – relative measure
    • Multiple of Median (MOM) – relative measure
    • Pay-TSR Alignment (PTA) – absolute measure
    • Financial Performance Assessment (FPA) – relative measure – assesses CEO pay rank and financial performance rank over a two- or three-year period using up to four financial metrics which vary by industry
  • Explain how the new Financial Performance Assessment (FPA) measure operates
    • Compares a company’s financial and operational performance over the long-term versus ISS peer group. Note: ISS has historical taken the position that you need a performance period of at least 3 years for it to consider the program long-term performance and yet, somehow it characterizes a two-year period of financial performance as long-term. FPA uses three or four financial metrics that are selected and weighted based on industry. The financial metrics that could be used include: return on invested capital (ROIC); return on assets (ROA); return on equity (ROE); EBITDA growth; and, cash flow (from operations) growth.
  • Explain how the FPA result will impact the final quantitative P4P concern level
    • FPA may affect the overall quantitative P4P concern level only if:
      • a Medium concern under any of the three initial tests (RDA, MOM, PTA), or
      • a Low concern but bordering the Medium concern threshold under any of the three initial tests
    • FPA can modify the overall concern up to Medium or down to low in the above cases. If the concern level under any of three initial tests is a High concern or the three initial tests result in a Low concern not bordering on Medium concern, then FPA modification is not be available.
  • Explain the time period used for TSR calculations for RDA
    • ISS uses a three-year period for measuring TSR ending closest to the fiscal year-end of the subject company. The TSR of the ISS peers will be measured over that same period. However, ISS will begin to average the closing prices across all trading days contained in the beginning and months of the TSR measurement period.
  • Explain which problematic practices are most likely to result in an adverse ISS vote recommendation
    • Repricing or replacing underwater stock options/SARs without prior shareholder approval (including cash outs)
    • Extraordinary perquisites or tax gross-ups
    • New or extended executive agreements that provide for:
      • Excessive CIC payments (exceeding 3 times base salary and average/target/most recent bonus)
      • CIC severance payments without involuntary job loss or substantial diminution of duties
      • CIC payments with excise tax gross-ups
      • Multi-year guaranteed awards that are no at-risk due to rigorous performance conditions, or
      • Liberal CIC definition combined with any single-trigger CIC benefits
    • Any other provision or practice deemed to be egregious and present a significant risk to investors
  • Explain how ISS will identify “excessive” levels of non-employee director pay and the impact it will have on its analysis
    • ISS is looking for extreme “outliers” in NED pay, which historically has represented pay figures above the top 5% of all comparable directors
    • If ISS finds excessive NED pay levels to exist, it may issue adverse vote recommendation for those board members responsible for approving/setting NED pay if no compelling rationale is provided
  • Explain how ISS will consider the new CEO Pay Ratio disclosure
    • ISS will display in its research reports: (1) the median employee pay figure; and, (2) the CEO pay ratio.
    • ISS will continue to assess the CEO pay ratio data as it becomes available and seek feedback from investors on the usefulness of this information and what should be done with it

 

U.S. Equity Compensation Plans: FAQs

This supersedes the preliminary FAQs issued in November 2017 about ISS’ Equity Plan Scorecard (EPSC) policy. These updated FAQs

  • Explain how ISS will treat the grant of time-vested restricted shares as consideration for an acquisition for purposes of its burn rate calculation
    • Generally, ISS factors all equity grants into its burn rate calculation. However, if companies grant time-vested restricted shares as part of an acquisition, they may request that such shares be excluded from the ISS burn rate calculation, but must provide tabular disclosure to enable ISS to determine the shares used in each of the three most recent years. Only time-vested restricted stock can be excluded under this policy; performance-based awards issued in an acquisition context will continue to be included. See the FAQs for a sample of the table that must be provided. Once companies make this initial disclosure, they should continue to provide it, even if they did not issue any time-vested restricted shares for acquisitions during the most recent year covered.
  • Clarified that all previous ISS burn rate commitments are now dead and of no force and that ISS no longer gives any special treatment to such commitments
  • Lay out the definition of “liberal change in control” and its impact on a plan with contains such a term
    • Means vesting triggers linked to: shareholder approval of the transaction, rather than its consummation; and/or an unapproved change in less than a majority of the board; and/or acquisition of a low percentage of outstanding common stock (15% or less); and/or announcement or commencement of a tender or exchange offer; or any other trigger that could result in windfall compensation without the occurrence of an actual change in control of the company.
  • Explain how ISS evaluates an equity plan proposal seeking approval of one or more amendments
    • Evaluated on a case-by-case basis
    • ISS will generally base its vote recommendation on the EPSC evaluation/score if any of the following apply:
      • the proposal includes a material request for additional shares;
      • the proposal represents the first time shareholders have had an opportunity to vote on the plan;
      • the amendments include an extension of the plan’s term; or
      • the amendments include the addition of full value awards as an award type when the current plan authorizes only stock option/SAR grants
    • If none of the four scenarios above apply, then ISS’ vote recommendation will depend on the overall impact of the proposed amendments, i.e. whether deemed beneficial or contrary to shareholders’ interests
  • Explain the factors ISS considers in its qualitative review of director pay for the purpose of a proposal seeking approval of a director equity plan
    • The relative magnitude of director compensation compared to companies of a similar profile
    • The presence of problematic pay practices relating to director compensation
    • Director stock ownership guidelines and holding requirements
    • Equity award vesting schedules
    • The mix of cash and equity-based compensation
    • Meaningful limits on director compensation
    • The availability of retirement benefits or perquisites
    • The quality of disclosure surrounding director compensation
  • Lay out the changes to the EPSC policy for 2018
    • Passing score for S&P 500 companies was raised from 53 to 55 points
    • The CIC vesting factor was made binary – either full or no points are no earned depending on whether plan complies with the ISS CIC vesting requirements:
      • For performance-based awards: acceleration is limited to actual performance achieved, pro-rata of target based on the elapsed portion of the performance period, a combination of both actual & pro-rata, or the performance awards are forfeited or terminated upon a CIC, and
      • For time-based awards: acceleration cannot be automatic single-trigger or discretionary
    • The holding requirement factor was made binary – either full or no points are earned depending on whether all awards require a holding period of at least 12-months. No points are given if the holding period is less or the holding requirement applies until stock ownership guidelines are met.
    • The CEO vesting requirement factors were made binary – either full points or no points depending on whether the vesting period is at least 3 years from the date of grant
    • The broad discretion to accelerate vesting factor was updated so that full points are earned only if discretion is limited to cases of death and disability. Discretion to accelerate vesting upon a CIC will cause no points to be awarded under this factor unlike current policy which would give full  points. The ability to use discretion to accelerate vesting in any other situation would cause the plan to lose all points under this factor.
    • ISS adjusted certain factor scores, per ISS’ proprietary scoring model.
  • Explain how the EPSC models differ now
    • Generally the same as current policy, except that the maximum points for S&P 500 and Russell 3000 companies under the Plan Features and Grant Practices pillars have been revised to be: 19 and 36 points, respectively.
  • Explain the EPSC points required to receive a positive ISS vote recommendation
    • S&P 500 companies now must score 55 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
    • All other companies must still score 53 or more points under the EPSC model to receive a positive ISS vote recommendation for their equity plan proposals
  • Explain the ESPC factors, whether they are binary and if weighted equally
    • See chart in the FAQs on this. But note that ISS does not give out the actual points attributed to each factor
  • Lay out when repricing provisions will constitute and overriding factor that would cause ISS to recommend against a plan proposal regardless of EPSC model score and other analysis
    • If the plan would permit repricing of stock options/SARs without shareholder approval it would constitute an overriding factor.
  • Explain how ISS evaluates whether a plan meets the minimum vesting requirement
    • The plan must mandate a vesting period of at least one year for all equity award types grantable under the plan, which applies to no less than 95% of the shares authorized for grant. Exceptions to the minimum vesting beyond 5% will prevent a company from getting points under this factor. Also if the plan permits individual award agreements or other mechanisms to reduce or eliminate the minimum vesting requirement, the plan receives no points under this factor.
  • Explain how ISS determines the treatment of performance-based awards that may vest upon a change in control
    • ISS will consider whether the amount of the performance award that would be payable/vested upon a CIC is (a) at target level, (b) above target level, (c) prorated based on actual performance as of the CIC date and/or the time elapsed in the performance period as of the CIC date, or (d) based on board discretion. Of the plan is silent, it will be treated as discretionary.
  • Explain how ISS determines the vesting period for a CEO’s most recent equity grants
    • For time-vested awards, full vesting should not occur until three years from the date of grant
    • For performance-based awards, ISS will give credit for a vesting period of slightly less than three years from the grant date so long as the performance measurement period is three years, if the reason is due to the grant date being within the performance measurement period. For performance-based awards that are subject to subsequent time-based vesting, only the performance-contingent portion of the vesting period is counted.
  • Explain how ISS will evaluate an equity plan amendment proposal when the company does not disclose the updated plan document
    • ISS may recommend against the plan amendment proposal because the company has not provided sufficient information to enable shareholders to fully evaluate the revised plan
  • Lay out the new 2018 Burn Rate Benchmarks
    • See the Appendix to this FAQ

 

Pay-for-Performance Mechanics (U.S.)

Those that were hoping that ISS would go into more sufficient detail so that they might be able to determine how they will fare under ISS’ quantitative P4P assessment are likely to be a bit disappointed.  While ISS does give some direction on how it will the P4P quantitative test will work, it stops short of giving sufficient details for a company to calculate these on its own. So much for transparency. But, I guess too much transparency is bad for the bottom line and if companies could calculate how they would fare under the ISS quantitative P4P tests they might need to purchase P4P simulation modeling from ISS Corporate Solutions (ISS corporate services arm).

However, this document does lay out a change in the concern thresholds under the Multiple of Median (MOM) test for S&P 500 companies. For S&P companies, the level that triggers a medium concern level has decreased from 2.33x to 2.00x. For non-S&P 500 companies, the medium concern threshold under the MOM test remain at 2.33x.

While this document does lay out the metrics that will be used for FPA for each GICS group, it does not specify the weighting of those metrics.

 

 

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ISS Issues 2014-2015 Policy Survey Results

On September 29, 2014, ISS released the results of its 2014-2015 Policy Survey. ISS highlighted several survey results related to compensation matters, including:

  • Responses regarding pay for performance; and
  • Equity plans.

Pay for Performance (P4P)

ISS highlighted the responses to several survey questions that dealt with P4P. ISS indicates that investors liked the idea of having CEO pay limits relative to company performance (27% of investors supported, while only  12% of issuers agreed). The magnitude of CEO pay was considered when evaluating pay practices by 24% of investors and 50% of issuers. Based on these responses, and the additional follow-up questions, ISS may propose a refinement to its P4P policy that does more to evaluate the CEO pay versus both absolute and relative measures.  Currently, the ISS P4P policy compares a CEO’s pay to that of the median CEO pay of the ISS peer group for the company.  So, we’ll have to see if this means ISS will add two components to the CEO pay evaluation–both a relative and absolute analysis–and how these will factor into the overall quantitative concern level.

Equity Plans

ISS indicates in the survey results that it will be revising its equity plan policy for the 2015 proxy season (i.e., for shareholder meeting held on or after February 1, 2015). According to the narrative, ISS will implement a “balanced scorecard” approach for evaluating equity compensation plans that will evaluate the proposal under three categories:

  • Cost;
  • Plan Features; and
  • Company Grant Practices.

ISS indicates that issuers supported a weighting of these categories as follows:

  • 70% of investors supported weighting of 30% to 50% for Cost, with 40% being cited most often;
  • 62% of investors supported weighting of 25% to 35% for Plan Features; and
  • 64% of investors supported weighting of 20% to 35% for Grant Practices.

ISS has given no indication of what the final weighting will be, but they could be 40/30/30.  Additionally, ISS did not necessarily explain what was included in each fo these broad categories.  While I assume “Cost” refers to the ISS Cost calculated for an equity plan proposal using ISS’s ISSue Compass model, it is not absolutely certain that ISS won’t introduce some additional factors into the Cost category. The same holds true for the other categories, Plan Features and Grant Practices, which, conceivably, ISS already addresses in its proxy reports on equity plan proposals.  However, there is no indication if there will be additional features (such as liberal share counting) that might cause a proposal to lose all the points under the Plan Features category. Likewise, while Grant Practices probably includes the ISS Burn Rate evaluation, it is by no means absolutely certain that is all it will include.  It also isn’t clear to me what will happen if a company exceeds the ISS Burn Rate Cap but makes a public commitment, will that still be viewed as an override and cause a company to not lose points under the Grant Practices category?

The possibilities are numerous and, unfortunately, not touched upon in these survey results.  However, they do indicate a significant reorganization to the ISS equity plan proposal policy and all companies should keep an eye out to see what the actual draft policy looks like and try to understand what differences exist from the current policy and how that might impact share requests.

 

A copy of the ISS Press Release announcing the survey results can be found here:

http://www.issgovernance.com/iss-releases-results-annual-global-voting-policy-survey/

 

The actual 2014-2015 Policy Survey results can be found here:

http://www.issgovernance.com/file/publications/ISS2014-2015PolicySurveyResultsReport.pdf

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Speaking at NY Compensation Association on 10/19

On October 19, 2012, I will speak at the New York Compensation Association’s meeting in New York City on The Impact of Proxy Advisory Firms on Executive Compensation: How Have Companies Responded, What Might They Do, and What Does It Mean for Executive Compensation?

For more information, please see the New York Compensation Association’s website: http://www.nycomp.org/meeting.asp

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