There are no significant changes to Vanguard’s “executive pay” policies this year, although the updated policies do tighten the language in a few places, e.g.:
– Referring to “long-term returns” (rather than “long-term value”)
– In the context of assessing alignment between incentive targets & strategy, the language clarifies that the company sets its strategy
– Noting that, where pay-related proposals consistently receive low support, the funds look for boards to demonstrate “consideration of” shareholder concerns (rather than “responsiveness to” – although the “responsiveness” language still appears elsewhere, so don’t consider this a free pass to ignore feedback)
– For determining whether there is concern with a peer group, the policy clarifies that Vanguard is looking at whether the company’s disclosed peer group is not aligned with the company in size or sector
As Dave noted, the 2025 policies also take a more general approach to proposals, versus signaling how it will approach particular topics. Included on the cutting room floor is commentary about shareholder proposals that request disclosure of workforce demographics, such as EEO-1 reports. In addition, Vanguard eliminated a paragraph about its voting criteria for annual or long-term bonus plans and other proposals relating to executive pay – which had been similar to the say-on-pay & plan analysis disclosed elsewhere.
People are optimistic that we’ll see more IPOs this year. If your company is considering going public, this ClearBridge Compensation Group memo outlines equity compensation issues that should be part of the planning. Here are the key takeaways:
Establishing a Stock Plan
▪ Median initial share pool is 10% of basic common shares outstanding (“CSO”)
▪ Majority of companies include an evergreen provision upon going public (~4% to 5% of basic CSO annually), recognizing they are almost always removed when shareholder approval is next requested
One-Time Special Grants in Connection with Going Public
▪ For CEOs, grants typically range from ~0.5% to 2.5% of market cap at grant, with an inverse relationship between market cap and grant value as a percent of market cap (i.e., grant values as a percent of market cap are generally higher at companies with lower market caps and vice versa)
▪ Over 2/3 of these grants include a performance-based vehicle such as stock options or performance share units (“PSUs”), often in combination with time-vested restricted stock units (“RSUs”)
▪ Most common performance metric is stock price/total shareholder return (“TSR”)
Go-Forward LTI Compensation
▪ >90% of public companies grant LTI on an annual basis, typically limited to more senior levels in the organization (e.g., directors and above)
▪ Common to initially solely grant time-vested vehicles (e.g., RSUs) annually, with companies generally beginning to introduce performance-vested LTI (e.g., PSUs) annually within 3 years
For even more info about compensation-related considerations before going public, check out the full memo – as well as Meredith’s blog last fall about “cheap stock” and other issues. Also visit our “IPOs” Practice Area for more resources.
This HLS Blog post by ISS discusses the balancing act companies play when considering the terms of their equity plans and award agreements. On the one hand, compensation committees want flexibility to administer these programs to best attract and retain employees. On the other hand, investors prefer certainty and want to know that equity incentive plan shares will be used reasonably.
To see how companies are managing this balance, ISS studied trends in key plan terms since 2020 with a focus on minimum vesting requirements, payment of dividends and dividend equivalents on unvested awards, limits to the administrator’s capacity to accelerate awards, liberal share recycling, vesting conditions upon a change in control, repricing and cash buyouts and evergreen provisions. Here are the key takeaways from their review:
– No more than 15% of equity plans on the ballot over the past five years limit the plan administrator’s capacity to accelerate awards.
– Companies’ inclusion of Minimum Vesting Requirements within their plans has remained consistent. Over the past five years, four out of 10 equity plan proposals contain minimum vesting provisions.
– Although considered a problematic practice, there was a 5% increase in plan proposals with evergreen provisions within the Russell 3000 index in 2023.
– The prevalence of S&P 500 companies prohibiting the liberal share recycling of full value awards has decreased from 78% in 2020 to 70% in 2023. The same trend was observed for the liberal share recycling of appreciation awards, which decreased from 94% in 2020 to 90% in 2024.
One of the final enforcement actions announced during Gary Gensler’s tenure as SEC Chair highlights one of the many traps for the unwary when modifying stock awards. The Cooley PubCo blog describes this commonly considered scenario at issue in the enforcement action:
Celsius, a developer and seller of fitness energy drinks traded on the Nasdaq Capital Market, usually provided that unvested stock awards to employees and directors would be forfeited if the individual left the company. However, in the second and third quarters of 2021, the SEC alleged, for six departing employees and retiring board members, “Celsius accelerated the vesting periods or allowed vesting to continue past their departure date, so the stock awards to these individuals would not be forfeited or cancelled upon their departure.”
ASC Topic No. 718 governing Stock Compensation requires a revaluation of awards as of the date of any modification, which includes changes to the vesting terms. The SEC alleged that the company did not have adequate internal accounting controls to reasonably assure that any equity award modifications were properly accounted for and, as a result, no one “consulted” ASC 718 or took steps to ensure the modifications were accounted for in accordance with GAAP. This caused some issues:
In a current report on Form 8-K filed in March 2022, the company disclosed that its stock-based compensation expenses had been materially understated for two quarters, and that, as a result, Celsius had overstated net income by approximately 400% for the three months ended June 30, 2021, and understated net loss by approximately 130% for the three months ended September 30, 2021. In its 2021 Form 10-K, the company included restated financial information for the periods ended June 30, 2021, and September 30, 2021, which “caused Celsius’s previously reported net income to become a net loss for the three- and nine-month periods ended September 30, 2021.”
Anytime you’re considering changes to outstanding equity awards, it’s time to consult the accountants and lawyers. The proxy disclosure implications of modifying equity awards are discussed in the “Executive Compensation Disclosure Treatise” — including in the “Summary Compensation Table” Chapter and the “Equity Tables” Chapter.
As we reminded readers in December, the 2021 American Rescue Plan Act amended the definition of “covered employees” under Section 162(m) of the Internal Revenue Code — currently limited to a company’s named executive officers — to add a public company’s five highest compensated employees (even if they are not executive officers) for tax years beginning January 1, 2027 and thereafter. Earlier this month, the IRS and the Treasury Department issued proposed regulations to implement the change. This Gibson Dunn alert describes the proposal as follows:
The proposed regulations clarify a few points in determining who qualifies as one of the next five highest compensated employees who make up these additional “covered employees.” Specifically, companies will need to consider all of their common law employees and officers, as well as employees and officers of any member of the company’s affiliated group. Employees for this purpose also include employees of related management entities or professional employer organizations who perform substantially all of their services during the taxable year for the publicly held corporation or members of its affiliated group . . . These additional highly compensated employees may change from year to year and will not remain “covered employees” in perpetuity.
In ranking employees to determine who is the most highly compensated, companies must look at compensation that would be deductible in that tax year but for the application of Section 162(m). As a result, compensation that may be granted in 2025 or 2026 but that is includible in income and deductible by the company in 2027 will be counted forpurposes of determining who is an additional “covered employee” for the 2027 tax year. This may have an immediate impact on companies’ annual compensation planning and how they account for tax for financial statement purposes.
The five highest compensated employees for a given taxable year may include individuals who were already among the company’s covered employees by virtue of previously being a named executive officer for a prior taxable year.
FW Cook argues that the proposed rules’ coverage of employees of other organizations who perform substantially all of their services for the public company during the taxable year is overbroad and potentially pulls in situations that the rule is presumably not intended to capture. For example, the memo suggests that the rule could capture outside counsel or outside consultants working on a large litigation or project or even, for the entertainment industry, an actor in a year a movie is being filmed. The comment period runs until March 17, 2025, and FW Cook urges potentially impacted companies to submit comments.
In 2023, the SEC Staff was asked about the application of the first Form 10-K clawbacks checkbox when a company is required to restate interim results. The Staff informally commented that if financial statements included in the 10-K are not required to disclose the correction of an error because the error only existed in interim periods, it would not object to an issuer’s decision not to check the box on the Form 10-K. This Weil proxy season alert has this important reminder that the SEC’s guidance noted that Item 402(w) disclosures may still be required in this situation:
Item 402(w) of Regulation S-K requires proxy disclosure concerning a company’s action to recover erroneously awarded incentive-based compensation in proxy and information statements in which Item 402 compensation disclosure is required . . .
Companies should take note that the SEC Staff confirmed through informal guidance that while the 10-K checkbox does not need to be checked as a result of material corrections to interim financial statements where annual periods are not affected by the errors, companies must still provide the disclosures required by Item 402(w). This suggests the possibility that a correction of interim financials could be an accounting restatement that could require a clawback if, for example, incentive-based compensation is based on interim period financial results.
This brought to mind the “1st half/2nd half” annual incentive plans adopted in response to COVID-19 uncertainty. Some companies may have continued that approach.
Meridian recently published surveys of both CEO and CFO compensation reported by S&P 500 companies for the period 2020 through 2023 (based on proxy statements filed in 2021 through 2024). Here are trends for CEOs:
– Median total compensation in 2023 was $15M – The median compound growth rate of CEO total compensation dropped from 5.4% prior to 2021 to 2.8% since 2021 with the pandemic decreasing pay outcomes. CEO pay grew only modestly above inflation levels over this period.
– Pay growth was volatile, more “saw-toothed” – Compensation fell for many in 2020 due to profound economic downturn, rose in 2021, fell again in 2022 and then increased in 2023.
– Overwhelming majority of CEO pay is delivered in long-term incentives (LTI) – Salaries grew more slowly at ~3% annually while grant values of LTI grew 7%-8% annually; since LTI is reported at its grant date value, realized values can be higher or lower than reported.
– Newer CEOs (much like other roles) earn less than experienced CEOs – Total compensation for CEOs hired in 2021-22 vs. those hired in 2020 dropped, suggesting higher compensation was required to attract a new CEO at the height of the pandemic than in later years.
And here are a few trends for CFO compensation:
– Median total compensation in 2023 was $4.9M – The median compound annual growth rate of CFO total compensation since 2020 was 5.9%, but only 3.2% since 2021 with the impact of the pandemic.
– Pay increased throughout this period albeit somewhat unevenly post-pandemic – Salaries grew at ~3.6% annually while grant values of LTI have grown 6.3% annually.
– Newer CFOs (similar to other roles) earn less than experienced CFOs – Total compensation for CFOs hired in 2021-2023 vs. those hired in 2020 dropped, suggesting higher compensation was required to attract a new CFO at the height of the pandemic than in later years.
With the new disclosure requirements under Item 402(x) coming online for calendar-year companies in the 2025 proxy season, companies are bracing for more scrutiny of equity grant practices. Even if everything is on the up & up, the new disclosures could invite questions and second-guessing that most of us would prefer to avoid.
This DLA Piper memo offers several housekeeping tips to help ensure that awards are granted and structured in a way that avoids MNPI and accounting issues, or other challenges. Here’s an excerpt:
Implement a formal equity grant policy. Adopt a written equity grant policy that outlines the terms and procedures that must be followed when making an equity grant, including authority and delegations, timing, and communication of awards. This should be considered comprehensively with other policies and procedures, such as the insider trading policy and nonemployee director compensation policy, to ensure such policies work together properly and can be disclosed in a clear and consistent manner.
Delegate authority responsibly. To optimize the impact of awards and ease administration, the compensation committee may wish to delegate certain authority to subcommittees, management, or third parties to administer or implement equity grants. Because the purpose of compensation committees, however, is to provide independent oversight of management and compensation programs, any such delegation should be formally approved by the committee and subject to appropriate oversight, limits, and reporting. Confirm that any such delegation is permitted by the compensation committee’s charter, the plan itself, and any applicable laws or regulations.
Mitigate insider trading risks with timing of grant or settlement of awards. Consider utilizing pre-established grant dates that coincide with regular board or committee meetings, or occur shortly after the release of quarterly or annual financial results, to avoid concerns that the company misused material nonpublic information (MNPI) that is not reflected in the grant date fair value of the award. A “spring-loaded” award that enjoys an immediate lift in value when earnings are announced may frustrate investors, create accounting complexity, and prompt legal challenges, while an award that immediately decreases in value after earnings may lose its intended incentivization effect.
Additionally, consider whether the future vesting and settlement of the award could create insider trading considerations. It is common for tax withholding obligations to be funded by “sell to cover” transactions into the open markets, which generally should not occur when there is MNPI. However, companies can develop strategies in advance to address such situations, such as the use of Rule 10b5-1 trading plans, automatic withholding of shares upon vesting with a value equal to the amount of withholding taxes, timing vesting schedules to align with “open” windows, or deferring settlement of vested awards subject to limitations under Section 409A.
As Meredith shared last week, there are some nuances in the disclosure rule that companies should consider even if they don’t grant options or SARs. That was one of the topics that we covered in our recent webcast on upcoming proxy disclosures – which is available on-demand for members of CompensationStandards.com.
About 5 years ago, we started to see compensation committees take on a greater oversight role for “human capital” matters. The expansion followed the #MeToo movement and investors pushing for more disclosure about workforce demographics, corporate culture, and other issues affecting employees. A recent memo from the EY Center for Board Matters says that 51% of S&P 500 companies now expressly disclose in their proxy statements that the compensation committee is responsible for human capital – up from 25% in 2021 – and that compensation committees have continued to rename themselves over the past few years to better reflect their role. Here’s more detail:
While some committee references to human capital management oversight are at a high level, others specify oversight of key strategies and programs, including those related to DEI; talent recruitment, development and retention; workplace safety and culture; health and wellness; and pay equity. Notably, references to culture more than doubled (from 11% in 2021 to 24% in 2024). These changes are significant and reflect the board’s focus on the broader talent agenda and how it connects to the company’s overall transformation and resilience goals.
The memo suggests updating the committee charter to reflect new responsibilities – for the sake of clarity and to get “credit” with investors. But don’t add something to the charter unless the committee is actually doing it. The best way to ensure that discussions actually happen is to add them as an agenda item on the annual governance calendar.
This Aon article says that economic instability and heightened shareholder scrutiny of the use of positive discretion are putting pressure on companies when setting metrics for their LTI plans with three-year performance periods. Greater uncertainty makes it challenging to set “realistic, achievable and suitably challenging” goals.
For this reason, Aon is seeing more and more companies reconsider three-year performance periods in their LTI programs, with some of those companies opting to use a three-year averaging method for performance shares. This “hybrid” approach incorporates averages derived from three distinct one-year performance periods. The article says there are a number of potential benefits to this approach:
– Flexibility: Shorter performance periods enable boards to adjust to shifting market conditions and macroeconomic uncertainties, making goals more precise and achievable.
– Enhanced performance tracking: With realistic and timely internal and external financial data, incentive targets can be set appropriately. The averaging approach requires sustained achievement of long-term performance objectives.
The article says this approach achieves these goals while still demonstrating “to investors that the board has a long-term vision.” For example, the proxy advisors “generally favor cumulative long-term performance metrics,” but “averaging three one-year performance periods helps address their concerns about adopting shorter-term performance periods.” If you’re in this boat, consider your CD&A disclosure carefully since the article notes, “thoroughly communicating the reasoning behind the board’s long-term vision is crucial.”