Takeaways

Shareholder outreach and disclosure of a company’s efforts is critical if a company’s say-on-pay vote receives less than 80 percent support.
Avoid waiver of performance goals unless there is robust compensation discussion & analysis (CD&A) disclosure regarding why the changes were needed, and provide enhanced disclosure and explanations for any poor pay practices in executive contracts.
Remove evergreen share reserve increases if you are submitting an equity plan for shareholder approval.

Institutional Shareholder Services (ISS) and Glass Lewis have issued their annual policy updates and FAQs related to say-on-pay and compensation matters, effective for annual meetings beginning on or after February 1, 2020 (ISS) and January 1, 2020 (Glass Lewis). As we head into the 2020 proxy season, companies should keep the following tips in mind related to these policy updates as they evaluate their compensation plans and draft compensation disclosure for their 2020 proxy statements.

This summary supplements our top ten tips for 2019 regarding winning say-on-pay, which remain relevant and important to consider when drafting 2020 CD&As and compensation disclosure. Please see our alert “Winning Say-on-Pay: Top Ten Executive Compensation Proxy Tips for 2019.”

1.  Consider the revised ISS financial performance assessment to evaluate compensation arrangements in advance of ISS review.

ISS initially uses a quantitative screen in its evaluation of pay-for-performance that is based on three primary measures and one secondary measure. For 2020, the three primary measures will remain the same, but ISS announced that the secondary financial performance assessment (FPA) measure will be based on economic value added (EVA) metrics instead of the GAAP metrics that were used in 2019 (e.g., return on assets, return on invested capital, EBITDA growth and return on equity). The secondary FPA evaluation applies to the extent the screen results in a cautionary low or medium concern score. The FPA measures the alignment of CEO pay and company financial and operational performance over the long term (typically three years) against the company’s peer group selected by ISS. The new FPA will be based on four equally weighted metrics: EVA margin, EVA spread, EVA momentum versus sales and EVA momentum versus capital. If the FPA applies, a company should determine if it helps or hurts the primary screen and take any appropriate actions.

2.  Describe in 2020 CD&A the specific program changes made in response to shareholder feedback on say-on-pay vote.

Companies that received low shareholder support on their say-on-pay vote in 2019 (generally less than 80 percent) should include fulsome disclosure of their shareholder outreach efforts and any changes made based on that feedback in their 2020 compensation disclosure. Glass Lewis indicated there should be different levels of responsiveness based on the level and severity of shareholder opposition to the vote. It expects “robust disclosure of engagement activities and specific changes made in response to shareholder feedback” in the proxy statement, and it will consider recommending a vote against the 2020 say-on-pay proposal if this disclosure is lacking.

3.  Avoid one-time awards, fiscal year-end changes to compensation and awards and mid-year adjustments to annual bonus plans.

When analyzing a company’s pay practices, Glass Lewis will now not only look at compensation paid or earned with respect to the prior fiscal year, but it will also consider any changes to compensation and one-time awards made after fiscal year-end. A company will need to provide explanations for these changes and additional grants in its 2020 compensation disclosure. In addition, if a company exercises discretion to increase a short-term incentive award with respect to the prior year (such as an annual performance bonus), including lowering performance goals mid-year or increasing payouts above the level earned based on actual performance, Glass Lewis expects enhanced disclosure explaining why the changes were needed.

4.  Review named executive officer employment agreements to remove (or not renew) excess severance, single-trigger change in control benefits, tax gross-ups and multi-year guaranteed awards.

Glass Lewis will consider the design of executive payments and entitlements, including terms that are excessively restrictive on behalf of executives or that could incentivize executive behavior that is not in the company’s best interests, in its analysis of a company’s compensation programs. Certain poor pay practices in executive employment agreements, such as inappropriate severance entitlements, excessive or poorly explained sign-on incentives and guaranteed bonuses, may lead to a negative say-on-pay vote recommendation. Glass Lewis reiterated its disapproval of single-trigger change in control payments and excessively broad definitions of change in control, and reaffirmed that double-trigger change in control payments requiring the occurrence of a change in control and an involuntary termination (including a constructive termination) are best practice. Glass Lewis will view the amendment of an existing employment agreement without changing a poor pay practice in the agreement as a missed opportunity by the company to align its pay policies with current best practices.

5.  Remove evergreen features from equity plans submitted for shareholder approval.

For 2020, ISS will recommend that shareholders vote against a company’s proposal to approve a new or amended equity incentive plan if the plan includes a provision that automatically increases the number of shares available for grant under the plan each year (commonly referred to as an “evergreen” provision). ISS uses an “Equity Plan Scorecard” (EPSC) approach when evaluating whether to issue a positive vote recommendation for equity plan proposals. ISS will consider the inclusion of an evergreen provision as an egregious overriding factor that will result in a negative vote recommendation, regardless of the company’s EPSC score. Companies with shareholders that follow ISS vote recommendations will need to remove any evergreen provisions from an equity plan that is submitted to its shareholders for approval.

Attorneys on the Executive Compensation and Benefits team at Pillsbury are equipped to assist with drafting your 2020 CD&A and compensation disclosure to address these concerns. Contact an attorney on the Executive Compensation and Benefits team to learn more about this service.