Takeaways

Companies should clearly set forth the relationship between pay results and actual financial and total shareholder return (TSR) performance.
Companies should tell a good story on why their compensation programs benefit shareholders and disclose performance goals and results in a manner that is succinct and easy to follow.
Companies should consider litigation trends surrounding non-employee director compensation and changes to 162(m).

As calendar year companies complete their Compensation Discussion & Analysis (CD&A) in their proxy statement for spring shareholder meetings, they may wish to consider the following tips for a favorable Say-on-Pay result.

1.  Run the ISS CEO Pay-for-Performance Test Before Year End Decisions Are Made

The pay-for-performance test of Institutional Shareholder Services, in part, compares TSR and CEO compensation against an ISS-constructed peer group. If relative shareholder return ranks in the lower tier of that peer group, ISS may criticize CEO pay that ranks at or above the peer group median and issue a no-vote recommendation. Companies should carefully consider the risk of a no-vote before setting year end pay. Such results may also behoove companies to summarize next year decisions, to the extent made, for helpful context.

2.  Highlight Realized Pay in Down Years

Proxy statements which include a description of realized pay can mitigate concerns relative to high reported pay in years of poor TSR performance. Unlike reported pay for equity awards, which for the most part is fixed on the date of grant, realized pay represents the true value of equity awards over a given timeframe, can demonstrate alignment between company performance and CEO pay, and can avoid shareholder criticism of excess pay and poor performance. Finally, current year payouts (above or below target) on multiyear performance stock units should be emphasized as a strong component of pay for performance.

3.  Consider Removing Poor Pay Practices

Companies should carefully weigh the cost and benefit of certain “poor pay practices,” such as 1) excess severance and golden parachute excise-tax gross ups; 2) “front-loaded” equity grants that cover several years; and 3) shifting to discretionary compensation from performance-based compensation, in light of recent changes to Internal Revenue Code Section 162(m). In addition, companies may be criticized by shareholder advisors for setting performance plan targets below prior-year results. This is particularly true if ISS is going to conduct a “qualitative review,” i.e., an in-depth assessment when a company’s results under quantitative testing give ISS cause for concern.

4.  Build Out the Say-on-Pay Proposal

Companies that limit a Say-on-Pay proposal to the statutorily required disclosures may miss an opportunity to persuasively articulate their compensation strategy outside of the CD&A. Instead of providing minimum disclosure, public companies should consider building out their Say-on-Pay proposal to include the prior year’s company performance and compensation highlights. This can help build support to win the Say-on-Pay proposal.

5.  Executive Compensation Proxy Summary

Like the Say-on-Pay proposal, an executive compensation proxy summary can highlight the best features of a company’s compensation philosophy and performance, while simultaneously satisfying proxy advisors and improving transparency. Specifically, companies should be mindful of how the proxy summary creates a narrative for the prior year’s compensation and corresponding company performance.

In addition to Say-on-Pay, companies should consider the following best proxy practices:

6.  Avoid Perk Audits Through Accurate Reporting

This past year, the SEC settled an enforcement action against The Dow Chemical Company (Dow) for inadequate disclosure of their CEO’s perks in the company’s proxy statement. Dow agreed to pay $1.75 million in fines and implement an independent consultant’s changes to Dow’s disclosure policy. Public companies should consider a pre-emptive and privileged review of their disclosure policies and practices to avoid a similar SEC review, fines and any associated adverse publicity. See our prior alert, “Avoiding SEC Enforcement with Perk Disclosure Audits by Legal Experts,” for more information.  

7.  Review Non-Employee Director Pay

With increasing litigation focus on excess director pay and shareholder advisor activity (as discussed below) companies should expand the benchmarks and rationale for their non-employee director pay into a “mini-CD&A.”

At least two cases filed this year challenge “excessive” non-employee director (NED) pay. These involve allegations of excessive NED pay compared to company peer groups, inclusion of misleading or false information in company proxies and failure to set meaningful shareholder-approved limits on compensation. Companies should evaluate compensation against peers to ensure alignment and consider using a shareholder-approved non-discretionary compensation formula in order to qualify for protection under the business judgment rule.

In addition, starting February 1, 2020, ISS will vote against board members that approve “outlier” pay for NED unless qualitative factors justify the high comparative pay. ISS defines “outlier” pay as compensation in the top 2-3 percent of a company’s GICS and other index group. Qualitative “mitigating” factors include one-time onboarding grants for new NEDs, transaction payments, special committee service, extraordinary need and specialized scientific expertise. The effective date of this rule gives company boards a necessary window to conduct the appropriate strategic analysis and disclosure in advance of their 2020 shareholder vote.

8.  Accurately Report all Employee Hedging Policies

The SEC has approved final regulations requiring public companies to disclose hedging policies that offset losses from equity either granted as compensation or held, directly or indirectly, by an employee, officer or director. The rule notably applies beyond the C-suite, covering policies over both the rank-and-file and the board room alike. The new rules go into effect for fiscal years beginning on or after July 1, 2019. Companies should provide an adequate policy summary, or the full policy, in their proxy statements and before the effective date if possible.

9.  Determine the Median Employee for Pay Ratio Each Year

Companies may save time and money by determining the median employee on an annual basis for purposes of the CEO pay ratio disclosure. Generally, the SEC permits companies to identify the median employee once every three years, unless there have been certain changes to the employee population or employee compensation arrangements. However, companies must disclose a reasonable basis for using a prior year’s median employee. The cost and burden of this additional disclosure may outweigh that of simply determining the median employee on an annual basis. 

10.  Avoid Proxy Trolls and the Section 162(m) Trap

Companies implementing plan amendments pursuant to the repeal of Section 162(m) should exercise caution. For example, if a company is adding shares to a plan subject to shareholder approval, but has also removed the Section 162(m) award limits, it may receive a letter from plaintiff’s counsel that the proxy disclosure is incomplete and does not address how the requested shares can be used without the individual limits. Additionally, even without the Section 162(m) performance exception, ISS and institutional shareholders still expect to see preestablished performance goals and limits on executive pay.