Category Executive Compensation

Summary of Larry Fink’s 2019 Letter to CEOs

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Early this week, Larry Fink, the Chairman and CEO of BlackRock, issued his annual letter to CEOs of public companies in which BlackRock is invested. If you haven’t already done so, go read Mr. Fink’s 2018 letter to CEOs before proceeding (it will help you better understand this year’s letter). I’ll wait.

Click HERE to access Mr. Fink’s 2018 Letter to CEOs

Okay. So now you know that in 2018 Mr. Fink urged CEOs to detail their strategy for long-term growth, starting with their company’s purpose. Mr. Fink also announced that BlackRock would be a bit more active in ensuring that BlackRock’s index funds looked at how the companies they held stakes in were going to ensure long-term growth. The 2018 Letter announcement marked a significant change in how index funds at BlackRock would operate. Given BlackRock’s size, this change will have an impact on both the public companies in which it holds stakes as well as other index funds.

In his 2019 Letter, Mr. Fink further refines his message and indicates that laying out a purpose alone is insufficient. Instead, companies need to articulate how they will generate profits long-term and serve all of its stakeholders effectively.

Mr. Fink’s 2019 Letter also asks that CEOs provide leadership (where they can) to help tackle and perhaps solve, social and political issues that are confronting the countries, regions, and communities in which their companies operate. One of these critical issues is retirement. Mr. Fink believes corporations need to reassert their traditional leadership role with respect to retirement that they used to hold. Mr. Fink sees helping workers navigate retirement as leading to the creation of not only a more stable and engaged workforce, but also a more economically secure population in the places a company operates.

Noting the shift in attitudes of the younger generation and the impending large trans-generational asset re-allocation, Mr. Fink argues that corporate valuations will be influenced by the shift in values between the current and younger generations, and companies should recognize that shift and start acting in a manner that will minimize the impact on their valuations.

Finally, Mr. Fink announced BlackRock’s Investment Stewardship engagement priorities for 2019:

  • governance, including a company’s approach to board diversity
  • corporate strategy and capital allocation
  • compensation that promotes long-termism
  • environmental risks and opportunities, and
  • human capital management.

Mr. Fink indicates that BlackRock will not focus on a company’s day-to-day operations, but will seek to understand a company’s strategy for achieving long-term growth. He also reiterates what his 2018 Letter said, “for engagement to be productive, they cannot occur only during proxy season when the discussion is about an up-or-down vote on proxy proposals. The best outcomes come from a robust, year-round dialogue.”

Click Here to see Mr. Fink’s 2019 Letter to CEOs

ISS Issues FAQs and Burn Rate Benchmarks for 2019

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In November, ISS issued a set of preliminary Compensation FAQs (see http://edwardhauder.com/2018/11/21/iss-issues-preliminary-faqs-on-compensation-policies-for-2019/). Then on December 14, 2018, ISS issued its final set of Compensation FAQs for 2019, U.S. Compensation Policies, Frequently Asked Questions, Updated December 14, 2018. ISS then issued a set of updated FAQs for equity plans on December 19, 2018, U.S. Equity Compensation Plans, Frequently Asked Questions, Updated December 19, 2018.U.S. Compensation FAQs

U.S. Compensation FAQs

Below are the questions and answers that were updated by ISS in this set of Compensation FAQs.

19. Any changes in the quantitative Pay-for-Performance (P4P) for 2019? No, the quantitative P4P screens will remain the same for 2019.

21. Does ISS prefer companies to use TSR as an incentive program metric? ISS does not endorse the use of TSR or any specific metric in executive incentive programs.

42. How does ISS analyze “front-loaded” awards intended to cover future years? ISS is unlikely to support grants that cover more than four (4) years (i.e., the grant year plus three future years) because such grants limit the board’s ability to meaningfully adjust future pay opportunities in the event of unforeseen events or changes in either performance or strategic focus.

47. Which problematic practices are most likely to result in an adverse recommendation? The list includes:

  • Repricing or replacing underwater stock options/SARs without shareholder approval
  • Extraordinary perquisites or tax gross-ups
  • New or materially amended agreements that provide for:
    • Excessive termination or CIC severance payments
    • CIC severance payments without involuntary job loss or substantial diminution of duties or in connection with a problematic Good Reason definition
    • Problematic “Good Reason” termination definition that present windfall risks, such as definitions triggered by potential performance failures
    • CIC excise tax gross-up entitlements
    • Multi-year guaranteed awards that re not at risk due to rigorous performance conditions
    • Liberal CIC definition combined with any single-trigger CIC benefits
  • Insufficient executive compensation disclosure by externally-managed issuers (EMIs) such that a reasonable assessment of pay programs and practices applicable to the EMI’s executives is not possible
  • Any other provision or practice deemed to be egregious and present a significant risk to investors

48. How does ISS evaluate “Good Reason” termination definitions? Such definitions should be limited to circumstances that are reasonably viewed as an adverse constructive termination, and should be tailored to preclude potential windfall risk.

50. If a company becomes a “smaller reporting company” under the SEC’s revised definition, how will ISS assess reduction in compensation disclosure? Companies with scaled compensation disclosure requirements should continue to provide sufficient disclosure to enable investors to make an informed say-on-pay vote; ISS typically wants the disclosure to be sufficient for it and investors to meaningfully assess the board’s compensation philosophy and practices.

59. How would ISS view any compensation program changes made in light of the removal of 162((m) deductions? Shifts away from performance-based compensation to discretionary or fixed pay elements will be viewed negatively.

67. How does ISS apply its policy around “excessive” levels of non-employee director pay? If a company has excessive non-employee director (NED) pay without a compelling rationale in two or more years, it could cause ISS to recommend against directors. This policy will not be applied until February 1, 2020. If ISS identifies excessive NED pay at a company it will undertake a qualitative review to determine if concerns are adequately mitigated. In evaluating a company’s disclosed rationale, the following circumstances, if within reason and adequately explained, would typically mitigate concern around high NED pay:

  • Onboarding grants for new directors that are clearly identified to be one-time in nature
  • Special payments related to corporate transactions or special circumstances, or
  • Payments made in consideration of specialized scientific expertise.

ISS will evaluate payments made in connection with separate consulting agreements on a case-by-case basis. ISS will generally not view payments to reward general performance/service as compelling rationale.

68. What is ISS’ methodology to identify NED pay outliers? ISS will compare individual NED pay total within the same index and sector. Directors will be compared to other directors within the same two-digit GICS group and within the same index grouping. Index groupings for purposes of this policy are: S&P 500, combined S&P 400 and S&P 600, remainder of the Russell 3000 index, and the Russell 3000-Extended. The methodology will also recognize board-level leadership positions, limited to non-executive chairs and lead independent directors and individuals in these roles will be compared to others in the same role in their index and sector. The methodology will also recognize cases where there is a narrow distribution of NED pay within a particular sector-index grouping, i.e., where there is not a pronounced difference between the top 2-3% and the median director, this may be considered as a mitigating factor.

U.S. Equity Compensation Plans FAQs

Below are the questions and answers that ISS has updated with respect to this set of Equity Compensation Plans FAQs:

26. How will ISS treat plan proposals that are only seeking approval in order to qualify grants as “performance-based” under IRC Section 162(m)? Proposals that only seek approval to ensure tax deductibility of awards pursuant to Section 162(m) – now under the “grandfather rule” – and that do not seek additional shares for grants or approval of any plan amendments, will generally receive a favorable recommendation regardless of Equity Plan Scorecard (EPSC) factors (“positive override”), provided that the board’s Compensation Committee or other administering committee is 100% independent according to ISS standards.

27. How will ISS consider plan revisions relating to the 162(m) tax code changes? Plan amendments that involve the removal of general references to 162(m) qualification will be viewed as administrative/neutral. But, if a plan contains provisions representing good governance practices, even if no longer required under the revised 162(m) code, their removal may be viewed as a negative change in a plan amendment evaluation.

34. What changes were made to the EPSC policy for 2019? Beginning February 1, 2019, the following updates will apply:

  • The change-in-control vesting factor is updated to provide points based on the quality of disclosure of CIC vesting provisions, rather than based on the actual vesting treatment of awards. Full points will be earned if the plan discloses with specificity the CIC vesting treatment for both time- and performance-based awards. But no points will apply if the plan is silent on the CIC vesting treatment for either type of award or if the plan provides for merely discretionary vesting for either type of awards.
  • There is a new negative overriding factor for excessive dilution–greater than 20% for S&P 500 companies and greater than 25% for the Russell 3000 companies (other than the S&P 500).
  • Certain factor scores have been adjusted in accordance with ISS’ proprietary (black box) scoring model.

45. When will excessive dilution have an adverse recommendation implication for the equity plan proposal? Excessive dilution is an overriding factor that can be applied to S&P 500 and Russell 3000 companies. For S&P 500 companies, this override will be applied if dilution is greater than 20%. For Russell 3000 companies (excluding S&P 500), this override will be applied if dilution is greater than 25%. For this policy, ISS defines “dilution” as (A + B + C) / CSO, where A = number of new shares requested; B= number of shares that remain available for grant; C = number of unexercised/unvested outstanding equity awards; and CSO = common shares outstanding.

2019 Burn Rate Benchmarks

See Appendix A of the U.S. Equity Compensation Plans FAQs for a full list of ISS’ 2019 burn rate benchmarks for the S&P 500, Russell 3000 (excluding the S&P 500), and the Non-Russell 3000.

CtW Engages Companies on Anti-Competitive Employment Practices

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On August 29, 2018, the activist investor, CtW Investment Group, kicked off a new initiative to engage 30 major companies (click HERE to see the list of companies) concerning their use of anti-competitive employment practices, including non-competes, no-poach agreements, non-disclosure agreements, and mandatory arbitration. CtW asked each company it contacted to:

  • Review its employment contracting practices, including the use of any of these provisions.
  • Report the board’s findings to shareholders before the next annual meeting.
  • Commit to increased human capital management disclosure going forward.

CtW was concerned about the potential liability and costs associated with such anti-competitive practices.  CtW also sees these anti-competitive practices as constraining the ability of individual workers to seek out new opportunities, causing an artificial limit the pool of potential matches available to employers. CtW sees the recruiting difficulties reported by many employers and attributed to “skills shortages” as more plausibly explained by the limits of workers mobility that employers themselves impose.

CtW made available several documents about its efforts (click for the source documents):

We will have to wait and see what impact CtW’s initiative has on these anti-competitive practices.  But, if my removing these impediments to worker mobility ultimately helps companies secure they need to grow their businesses, it should be a win for everyone.  However, it may take some time to get companies, management teams and Boards comfortable with the notion of forgoing these “protections” for their workforce. But, if CtW and other institutional shareholders take up this initiative, and large companies begin to comply, as with most things, it could eventually filter out to a broad swath of U.S. public companies.

A Rose By Any Other Name?

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My ears always perk up when I hear about a “new” compensation design, especially when it revolves around long-term incentives (LTI) and trying to structure them to bring better alignment with shareholders.  So I paid attention several weeks ago when I was at the Southeastern Chapter of the Society for Corporate Governance’s annual meeting and heard a director say that he had worked with a management team to revamp their LTI program to make it better aligned with shareholders for next year  The director was Daniel G. Beltzman, director of Regis Corporation, who is also General Partner, Birch Run Capital Advisors, LP, an investor in Regis Corporation.

Critical Points of Regis Corporation’s FY19 LTI Design

  • One LTI Grant equal to 3.5x FY2018 LTI grant in FY19
  • Covers 5 years of LTI grants for an initial grant in FY19 covering approximately 3.5x the 2018 annual LTI grant (about 70% of what a participant would have received as annual grants over the 5-year period)
  • No additional LTI grants until after the 5 year period
  • Participants can get additional shares if they elect to defer up to 50% of their net, earned annual cash incentive into shares of company stock, for which the company will make a grant of RSUs equal to 200%. These RSUs have 5-year cliff vesting.

Initial Thoughts

This design is rather unique and more closely aligned with how LTI is structured in a company that is owned/controlled by private equity. It requires executives to invest money in the business to maximize their potential rewards.  Theoretically, this should help ensure that the executives will remain focused on what will drive the company’s stock price higher.

This plan will work so long as executive believe there is an upside to the company’s stock price in the mid-term, 5-year period.  If they decide there isn’t, they may go looking for new challenges, especially if the company enters into a scenario where the annual cash incentive plan doesn’t pay out and there is no additional investment possible in company shares which will be matched.  As long as the future looks bright for the company (at least from an executive perspective), this plan should help drive focus on the company’s goals that will lead to an increased stock price.  But, if the company’s prospects dim, then this design could cause some serious issue with morale and retention and could lead the company to award some form of supplemental incentives. This might increase the cost of this design to be higher than a traditional annual LTI grant-focused design.

The good news is that one of the company’s shareholders has already backed this design (and even helped create it).  So the company should not face the issue of trying to effectively communicate this design to all of its shareholders to convince them it is a good thing. Having a significant shareholder represented on the board and taking an active part in developing this design should ease concerns of other shareholders and make their buy-in to the design less of an issue for the company.

The real test of this design will be what happens.  No one has a crystal ball. Sometimes you have to design the best plan you can at the time given everything you can see and predict. If the future is bright for the company and no significant headwinds come to press against it and throw a spanner wrench into the works, then this design could be quite useful.  We will have to wait and see how things look in FY 2025 to be able to gauge if this design is a winner.  Furthermore, we will have to wait to see this design tested against falling company and market fortunes to see how well it holds up.  But for companies that have significant owners that want a “better” alignment between executives and shareholders, this design might offer at least another alternative to consider.  Time will tell whether LTI designed in such a way will smell as sweet as the typical, annual LTI grant approach.

For more information, please see Regis Corporation’s proxy statement filed for 2019, the CD&A begins on page 19, and the new FY19 LTI program is detailed starting on page 21:

https://www.sec.gov/Archives/edgar/data/716643/000114036118037937/bp11671x1_def14a.htm#regis-def14a_102318a11

 

Related EC Minute Episode

Episode 28 of the EC Minute also covers Regis Corporation’s new LTI design for fiscal 2019.

http://www.ecminute.com/2018/10/31/episode-28-a-new-lti-design/