Global Governance Advisors

Executive Compensation Disclosure - Best Practices as You Finalize Your CD&A

Posted by Peter Landers on May 6, 2019 9:00:00 AM
Peter Landers
Find me on:

The heart of proxy season is upon us with the majority of Annual General Meetings (AGMs) scheduled to take place over the next couple of months. These meetings will highlight shareholder votes on important issues such as the election of directors for the upcoming year and approval of the company’s auditors. In many cases, shareholders will also be voting on whether they approve or disapprove of the compensation provided to a company’s top executives (otherwise known as a “Say on Pay” vote) or re-approving a company’s equity compensation plans for employees. It is on these last two issues (Say on Pay and equity compensation plan approval) where a company’s disclosure on executive compensation can play a critical role in influencing the outcome of votes at the AGM.

In an earlier blog post, I discussed the importance of understanding what your options are from a disclosure perspective, in this article I am covering some best practices you can use to answer the three key questions that should be resolved through your disclosure on Top 5 Named Executive Officer (“NEO”) compensation:

  1. What was paid to executives?
  2. How was compensation paid to executives? and
  3. Why was compensation paid to executives?

There are many examples of best practices from a disclosure perspective that can be identified on an annual basis. Quite often, these best practices are summarized into annual reports by various organizations. One such publication is provided through DFin Solutions (formerly known as RR Donnelley & Co.) which publishes an annual Guide to Effective Proxies in the United States and Canada. This document provides readers with detailed examples of specific disclosure companies can use to better tell not only their compensation story, but other corporate governance and shareholder engagement efforts they have embarked on in the past year. In Canada, the Canadian Coalition for Good Governance (“CCGG”) also publishes an annual Best Practices for Proxy Circular Disclosure. Similar to DFin Solutions, the CCGG highlights specific examples of Canadian companies that provide the best disclosure in areas such as executive & director compensation, corporate governance and shareholder engagement, to name a few. These types of publications should be thought of as great resources for you to see how different companies approach disclosure and determine if these identified best practices can be adopted at your company.

It would take too long to identify all potential best practices from an executive compensation disclosure perspective, but I want to highlight a few specific examples of best practices that can be beneficial to companies as they finalize their 2019 proxy circular disclosures. These include:

  • Outlining what your company does and does not do from a compensation perspective
  • Summarizing how shareholder engagement has influenced executive compensation
  • Summarizing performance metrics used and how they impact compensation
  • Reported Pay vs. Realizable Pay
  • Summarizing key elements of your equity compensation plan

Outlining What Your Company Does and Does Not Do From a Compensation Perspective

A great way to summarize the key aspects of your compensation program to shareholders is to highlight the positive practices that you have put in place. This can include items such as: placing caps on annual bonus payouts, tying bonus payouts to specific performance objectives, annual review of the compensation peer group, the adoption of share ownership guidelines, the adoption of clawbacks on incentive compensation in the case of material misstatement or misconduct and/or having the ability to engage an independent third party to advise the Board on executive compensation. On the flip side, you can also use this section of your proxy disclosure to highlight the things you do not do from a compensation perspective. This could include items such as: not approving guaranteed and multi-year bonuses, repricing of underwater stock options, the use of Single Trigger Change of Control provisions and/or allowing executives to hedge the value of their long-term incentives. While I have highlighted a few areas you can choose to disclose, any positive attribute you feel shareholders should be aware of should be summarized in this section.

Example: Anadarko Petroleum – What They Do and Don’t Do

1-1

Summarizing How Shareholder Engagement Has Influenced Executive Compensation

In today’s environment, it is imperative that companies engage with their shareholders and listen to their views. One of the biggest areas for concern among shareholders surrounds executive compensation. With U.S. companies mandated to hold Say on Pay votes and the significant increase in Canadian firms voluntarily adopting Say on Pay, companies want to ensure that they receive strong support from shareholders on these votes. The embarrassment of receiving low support or even failing a Say on Pay vote is avoidable and one way to avoid this is by actively disclosing what you heard from shareholders around compensation and how you considered this feedback and made any changes. This can demonstrate your company’s commitment to engaging with shareholders and taking their concerns into account.

Example: Goldcorp – How Shareholder Engagement was Considered by the Company

2

Summarizing Performance Metrics Used and How They Impact Compensation

Shareholders are demanding more information to better understand why executives received the compensation they did in the past year. A good way to demonstrate this alignment is by summarizing the key performance metrics (both Corporate and Individual) that went into determining executive bonus payouts and Performance Share Units (PSUs) under the long-term incentive program. The disclosure of a balanced scorecard that outlines the performance metrics used, the weighting for each metric, the expected performance levels and expected payouts under “Threshold”, “Target” and “Superior” performance is the best way to do this. Companies can add to this by then disclosing the Actual level of performance achieved in the past year and the associated payout multiplier for each metric with a calculation of what the final bonus payout is for each executive. A similar approach can be used for PSUs outlining the expected performance levels over a 3-year performance period and Actual performance at the end of each 3-year period. This will show the impact of performance on the vested value of PSU payouts. This is all in the spirit of providing increased transparency to shareholders regarding your compensation program.

Example: Goldcorp – Summarizing Annual Performance Metrics and Impact on Compensation

3

Example: PepsiCo. – Summarizing PSU Performance Metrics and Impact on Compensation

4

Reported vs. Realizable Pay

With the goal of demonstrating the alignment between executive pay and performance over longer time periods, companies are increasingly providing supplemental disclosure that compares the value of compensation reported in the Summary Compensation Table with the “realizable” pay the CEO is entitled to at the end of each fiscal year. Often times, the reported pay figure in the Summary Compensation Table is quite different than the “realizable” pay figure. This is often the case in cyclical industries such as Oil & Gas or Mining where a certain grant value of Stock Options, RSUs and/or PSUs is provided to the CEO that appears quite high, but with downward pressures on share prices the actual “realizable” value is much lower as stock options are often out-of-the-money, PSUs may not be on track to vest and RSUs are worth much less than they were granted at due to a lower share price. By calculating and reporting on the “realizable” pay figure at the end of each fiscal year, either through a table or graphic and comparing it to the trend in your company’s share price, you can demonstrate the alignment between your company’s performance and executive pay levels more clearly.

Example: Suncoke Energy Inc. – Realizable Pay Disclosure

5

Summarizing Key Elements of Your Equity Compensation Plan

Receiving approval from shareholders on an updated equity compensation plan is becoming more difficult in today’s environment with ISS and Glass Lewis espousing specific voting guidelines that, if not met, could result in a recommending “NO” vote on your equity compensation plan. While disclosure of the full plan document text is recommended and viewed positively, these plan texts can be quite lengthy and complicated to review and understand. Increasingly, companies are summarizing the key elements of their equity compensation plan such as: Plan maximums, limits on non-employee director grant levels, vesting treatment under different termination scenarios and other key provisions in a short summary table or section within their circular with reference to the full plan text in an appendix. This highlight section found within the body of the circular provides shareholders with the most important elements of the plan they need to be aware of when making the decision of supporting the plan or not.

Example: United Parcel Service – Summarizing Key Elements of Equity Compensation Plan

6

Closing Thoughts

As you can tell, there are many ways in which to identify compensation disclosure best practices across North America with organizations providing specific examples of best practices you can reference and make your own. While there are many best practices to choose from, a few of the key practices to consider for 2019 include:

  • Outlining what your company does and does not do from a compensation perspective
  • Summarizing how shareholder engagement has influenced executive compensation
  • Summarizing performance metrics used and how they impact compensation
  • Disclosing Reported Pay vs. Realizable Pay
  • Summarizing key elements of your equity compensation plan

Executive compensation is becoming more complicated as the demand for more rigor and structure in determining compensation levels grows. This makes the need to simplify disclosure by summarizing the key features of your compensation program, the performance metrics used and how your pay aligns with company performance over time even more important. The use of summary tables and graphics to better tell your compensation story is also something to consider, as opposed to inundating shareholders with pages and pages of text. The scrutiny on executive compensation is higher than ever, so following disclosure best practices can only aid in ensuring the continued support of your shareholders and the avoidance of an unwanted result in approving your equity compensation plan or Say on Pay vote at your upcoming AGM.

Topics: Executive Compensation, Best Practices, CD&A