Summary of Larry Fink’s 2019 Letter to CEOs

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

2019 Exequity Equity Usage Calculator Available!

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I am happy to announce that Exequity’s 2019 Equity Usage Calculator is now available. This calculator is updated to reflect the latest ISS burn rate benchmarks and will calculate a company’s burn rate and run rate for the past 3 years and 3-year averages.

The calculator is available on the ‘Excel Tools’ page under the ‘Reference Materials’ page.

Click HERE to download the 2019 Equity Usage Calculator

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.

SEC Solicits Comments on Earnings Releases and Quarterly Reports

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Earlier this month, the SEC issued a press release announcing that it was soliciting comments on earnings releases and quarterly reports. Specifically, the SEC is seeking comments on how the existing periodic reporting system, alone or in combination with other factors, may foster an overly short-term focus by managers and other market participants.

The request for comments addresses the following:

  • The nature and timing of disclosures that reporting companies must provide in their quarterly Form 10-Q reports, including when the Form 10-Q disclosure requirements overlap with the disclosures companies voluntarily provide to the public in earnings releases furnished on Form 8-K.
  • How the SEC can promote efficiency in periodic reporting by reducing unnecessary duplication in the information that reporting companies disclose and how any such changes could affect capital formation, while enhancing, or at a minimum maintaining, appropriate investor protection.
  • Whether SEC rules should allow reporting companies, or certain classes of reporting companies, flexibility as to the frequency of their periodic reporting.
  • How the existing periodic reporting system, earnings releases, and earnings guidance (either standing alone or in combination with other factors) may affect corporate decision making and strategic thinking, including whether these factors foster an inefficient outlook among reporting companies and market participants by focusing on short-term results.

The SEC will accept comments through March 21, 2019.

The SEC Press Release can be found at, https://www.sec.gov/news/press-release/2018-287, and the version of the request published in the Federal Register can be found at, https://www.sec.gov/rules/other/2018/33-10588.pdf.