Executive Compensation: ISS on Pay-for-Performance

Background.  As we approach the second year (for most companies) of shareholder Say-on-Pay (SOP) voting, it might be useful to discuss the methodology used by one of the most important proxy advisory firms, ISS, in evaluating the alignment of executive pay with corporate performance.  The following is an excerpt (which I have edited slightly) from a recent Update on ISS Policy issued by Frederic W. Cook & Co., Inc.

 

Evaluation of Executive Pay.  “Under current ISS policy, pay-for-performance alignment for Russell 3000 companies is assessed by examining a company’s one- and three-year total shareholder return (“TSR”) relative to all Russell 3000 companies in the same 4-digit GICS industry group [fn 1]  and year-over-year change in CEO compensation for CEOs who have served at least two consecutive fiscal years. Generally, if both one- and three-year TSR are below median and there has not been a meaningful year-over-year reduction in CEO compensation (e.g., 10% or more), the company is deemed to have a pay-for-performance disconnect. This subjects the company’s overall executive compensation program to greater scrutiny and raises the likelihood that ISS will recommend “against” the company’s management say-on-pay (“MSOP”) proposal.

 

Methodology.  The updated policy for 2012 refines the methodology for determining pay-for-performance alignment as follows:

 

Peer Group Alignment:

  • The peer group for the relative TSR calculations will no longer be all Russell 3000 companies in a company’s 4-digit GICS industry group. Instead, this peer group will be the same as ISS’ pay comparison peer group, which will be formed on a new basis.
  • The peer group will generally consist of 14-24 companies (vs. 8-12 under the current policy) that are selected based on size using market cap, revenue (or assets for financial firms) and GICS industry group.  ISS clarified that it will seek to position the company being evaluated close to the median.
  • Both CEO pay and TSR will be evaluated on a relative basis compared to a company’s peer group over one and three years, weighted 40% and 60% respectively.
  • The weighted CEO relative pay rank will then be compared to the company’s weighted TSR rank. The system for evaluating the ranks was not included and will be provided in the additional guidance to be issued in December.
  • The multiple of CEO total pay to the peer group median, which is a qualitative consideration based on the most recent year’s pay under the current policy, will become quantified. Clarification was not provided whether this comparison will be expanded to include three-year CEO pay in addition to one-year pay.

1  GICS refers to the Global Industry Classification Standard (“GICS”) developed and maintained by Standard & Poor’s for the purpose of classifying companies into 2-digit sectors, 4-digit industry groups, 6-digit industries, and 8-digit sub-industries.

 

Absolute Alignment

  • CEO pay alignment will also be evaluated on an absolute basis against TSR over a five-year period. This analysis will assess the difference between the trend in annual pay changes and the trend in annualized TSR during the period.
  • The system for evaluating differences in rates of change to identify strong alignment and weak alignment was not included and will be provided in the additional guidance to be issued in December.
  • The updated policy did not indicate whether a change from using grant-date fair values for equity compensation to earned values would be made. However, we expect that ISS will continue to use grant-date fair values and continue to value stock options assuming the maximum term rather than actual experience of how long options are outstanding prior to exercise, as used for accounting and disclosure purposes. Thus, companies granting options will be even more disadvantaged under the new methodology.

 

Consequences of Poor Alignment.  Companies with unsatisfactory alignment will be subject to further qualitative analysis that considers the following:

 

  • The ratio of performance-based to time-based equity awards;
  • The overall ratio of performance-based compensation to overall compensation;
  • The completeness of disclosure and rigor of performance goals;
  • The Company’s peer group benchmarking practices;
  • Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc. both absolute and relative to peers;
  • Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices (e.g.; biennial awards); and
  • Any other factors deemed relevant.

 

The updated policy did clarify that a new CEO will not exempt a company from evaluation under the new methodology.”

 

Conclusion.  For larger public companies, we can expect increasingly close scrutiny of executive pay and greater criticism of perceived poor practices by proxy advisors.  Smaller public companies can expect an inevitable “trickle down” effect, even if it is watered down.  Our approach to advising compensation committees uses a similar (but simpler) methodology, understanding that our clients generally have boards that include major shareholders who are well-attuned to shareholder interests. 

 

   Bob Musick, Titan Group LLC                                          Richard Deutsch, Titan Group LLC

Robert L. Musick, Jr.                                 Richard Deutsch

(804) 249-6027                                      (804) 249-6026

bmusick@titanhr.com                                rdeutsch@titanhr.com

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Executive Compensation: Long Term Incentive Trends

Background.  We have discussed in recent years evolving trends in “total compensation”, especially in long term incentives (which typically are in the form of stock-based compensation.)  Changes have come slowly.  However, several significant events occurred during 2011—insider trading controversies, a downgrade in the U.S. credit rating, and mandatory Say on Pay voting for most U.S. public company shareholders—which seem to have accelerated the pace. While some of these events were unexpected, companies had been preparing for Say on Pay (and the Dodd-Frank Act) well in advance, and the threat of failing caused many companies to address vulnerabilities in the design of their compensation programs for the 2011 proxy season. As a result, the landscape of executive compensation saw more change this year in long-term incentive usage than in any recent year since 2007.

Setting the Table(s).  The Securities and Exchange Commission (SEC) initiated change at the end of 2006 by overhauling proxy disclosure rules, requiring public companies to provide more detailed information (both narrative and tabular) about executive compensation programs in their proxy statements. This provided shareholders, pension funds, activist investors, and proxy advisory firms more detail for scrutinizing pay-for-performance in executive compensation, and compelled corporations to consider changes to compensation programs.  As a result, in 2007 following the effective date for the new SEC rules, company usage of performance-based long-term incentives showed a marked increase.

Since then, long-term incentive practices have changed only modestly—until now. Armed with several years of expanded executive compensation disclosure in proxy statements, investors this year could voice their opinions by voting on any perceived link or disconnect between pay and performance. Further, with volatileU.S.and global economies, and investor displeasure with company performance, proxy advisory firms (ISS, Glass Lewis, etc.) are exerting greater pressure (if not influence) in recommendations on shareholder voting. These forces converged to bring about a considerable change in the executive compensation long-term incentive landscape, with a spike in the usage of performance shares and some simplification of grants in an effort for transparency.

Trends Among the Top 250.  Frederic W. Cook & Co. recently released its “Long Term Incentive Grant Practices for Executives 2011 Top 250 Report”, and quoted below are key findings:

“• For the first time in the history of this report, the use of long-term performance shares now is more prevalent than the use of stock options, while the prevalence of time-vesting restricted stock awards appears to have stabilized.

• Stock options continue to decrease in prevalence, but are not expected to go away, as they are by nature a performance-based long term incentive vehicle and a common complement to full-value share awards.

• Variations of basic grant types (like “premium” or “performance accelerated” stock options), common in years gone by, have dwindled and are on the brink of extinction, perhaps casualties of greater transparency and simplicity in a Say on Pay environment.

• Vesting periods of awards, and performance periods for performance awards, remain stable at three years.

• The use of profit measures and total shareholder return in long-term performance plans continues to be the most widely used performance categories, and the prevalence of types of measures used for performance awards has stabilized.”

Trickling Down Trend?  What conclusions, if any, should we draw from the Cook report?  First and foremost, we admit that what the Top 250 companies do and what smaller publicly-traded companies usually does differ considerably in amount and degree, but we also acknowledge the inevitable “trickle down” effect.  Beyond that:

  • As we have noted on many occasions, the use of full value grants (restricted or performance-vested stock) continues to find favor among investors, as well as regulators.  There are good reasons for this.
  • As we see further iterations of disclosure, greater attention is being paid to “outliers.”  We have written about the relatively modest fallout from the first round of Say on Pay, but the full story has yet to be told.
  • No executive compensation “story” can be told effectively without linking pay and performance with transparency.  Hiding the ball is not an option.
  • Efforts to promote good governance, especially in the area of executive compensation, are here to stay.  Even as we await another raft of regulations under Dodd-Frank (and others), now is a good time to review the fundamentals.

 Bob Musick, Titan Group LLC                                                           

Robert L. Musick, Jr.                                     Richard Deutsch

(804) 249-6027                                            (804) 249-6026

bmusick@titanhr.com                                   rdeutsch@titanhr.com

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My Visit with White House Staff

I recently joined 23 other executives and CEO’s from Virginia to attend a briefing with White House staff members in conjunction with The Office of Public Engagement (OPE).  The OPE helps open the two-way dialogue, ensuring that the issues impacting our communities have a receptive team dedicated to making their voices heard within the Administration. 

We spent two hours hearing from several White House staffers, including the Deputy Director of Public Engagement, the Deputy Director for White House Energy Policy, the Chief Technology Officer for the White House and the Executive Director of the White House Business Council.

 

Most of the time was spent listening to staff members brief us on the initiatives in place to stimulate business and the economy.  I won’t go into the gory detail, but the key items mentioned included 1) a discussion about activities designed to stimulate small business growth in technology in the health, energy and manufacturing sectors, 2) broadening access to electronic data in all sectors, 3) expanding domestic production in oil and gas (unfortunately, Virginia offshore oil leases will not be part of this), 4) expanding energy efficiency, and 5) investing in clean technologies. 

Another briefing was on the American Jobs Act (a handout was provided) and it was mentioned that many of the ideas were generated from business leaders.  Finally, a recent report from the President’s Council on Jobs and Competitiveness was mentioned.  The link to this report is below.

 

Jobs Council Releases “Taking Action, Building Confidence” Interim Report to the President | President’s Council on Jobs and Competitiveness

 

My only disappointment was that a representative from Health and Human Services did not attend.  A one hour delay in getting our security clearance through Secret Service systems caused that topic to be dropped from the agenda.  I also found out that November was proclaimed National Entrepreneurship Month by President Obama.  We all received our own copy of the proclamation with the President’s seal and signature.  Overall, this was a very interesting and productive day and an experience that I will not soon forget.

 

Lee Weisiger, Partner, Titan Group LLC

 Lee Weisiger

Titan Group LLC

Partner

lee@titanhr.com

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NCEO Executive Compensation Survey

As we have discussed, good comparative data for executive compensation practices in ESOP companies are hard to come by.  One of the few useful sources we have access to is the periodic (typically, every two years) survey done by NCEO.  However, the survey is only as good as the number and accuracy of the responses.

 You don’t have to be an NCEO member to participate, but by responding, you can help make the survey results more meaningful.  As a client of ours, you may call on us to advise on matters of executive compensation from time to time, and this survey will be important.  If you can spare a few minutes to participate, here is the link.

 https://www.surveymonkey.com/s/executivecomp2011

Bob Musick, Titan Group LLC

Bob Musick

804.754.8330

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Simplify and Get Talent Management Practices Used

I am a big fan of Marc Effron’s book One Page Talent Management.  His basic premise is that Optimal or Best Practice talent management processes are USELESS if they are not used – simple premise, right?  Short, straightforward, practical tools aligned with your business environment will yield the best results for your company.  He challenges HR professionals to always ask the question – Is the additional value (of the change, improvement, addition I am making) equal to or greater than the added complexity?    Only by being experts in our HR science and our businesses can we really answer that question.

So…do you need to ask 150 questions on that employee satisfaction survey or will 15 really give you some actionable data?  Do you need 12 core competencies, or will 5 best articulate what your organization is best at?  Is a 10 page performance evaluation form something that associates can recall and take action on, or would a 1-2 page streamlined version work better?

…simplify and get talent management practices used.

Alison Miller, Principal

Alison Miller

Titan Group LLC

804.754.8330

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What it takes to be Named HR Strategist of the Year

I recently had the pleasure of speaking with Deborah Slayden, Director of Workforce Development Straegy with VCU Health System (VCUHS), regarding her incredible journey to be selected as the 2011 Human Resources Strategist of the Year by the Titan Group and Richmond Society of Human Resources Management.  When she learned she won the award, she was very surprised and elated, especially given the talented competition, and the stature of previous winners including Bonnie Shelor, Bon Secours and Dr. Christopher Lee of the Virginia Community College Sysyem.   “For me this is like winning a lifetime achievement award” noted Debbie who has worked with the VCU Health Care System for over thirteen years.

 Debbie began her career after graduating from Braxton Business School and became a secretary as many of her peers did at the time.  She worked at Henrico Doctors Hospital for the head of Personnel, Steven Bryan, who was instrumental in shaping her future in Human Resources (HR).  He gave her many opportunities to try out different roles such as the front desk, benefits coordinator, employment manager and eventually, she served as the HR Director.  Knowing that her career climb would be slowed down without further education, she decided to complete not only her bachelor’s degree, but also her MBA and MSHA, both of which she did under her VCUHS’ educational program with little cost to her.  She realized that to be even more effective and able to think strategically as an HR pro, she needed to better understand how business works, which was the main reason she decided to earn her MBA.

Debbie attributes most of her success in her current role to the “huge support” she gets from her manager, Maria Curran, and her team.  When she moved into this role about five years ago, she was given a clean slate and the reins to create whatever she thought was needed to create a work environment worthy of being an employer of choice.  This was a strategic initiative for VCUHS particularly given the competition for highly skilled medical candidates.  She envisioned a place where job applicants would be so excited to work for them that they would form a line wrapped around their building.  As a result of Debbie’s leadership and the HR team’s ideas, she developed a program called H.O.P.E., which stands for Housing, Opportunity, Potential and Education.

 To help employees with Housing needs, VCUHS offers first time home buyers up to $7,500 on closing costs.  They also will assist in educating their employees on how to improve credit scores and consolidate debt. 

 Within the Opportunity bucket, Debbie created a multitude of professional growth and training programs.  Many classes are focused on preparing employees for their future and honing their management skills or offering scholarships for nurses who want to earn their RN status.  They try to develop whatever programs are needed to help employees achieve their dreams from basic needs like babysitting, to offering transportation or housing.  A really fresh program aimed at youth is JRIIS – “JumpRope to Stethoscope” that partners their nurses with local schools to introduce middle school students to the world of medical careers.  It works!  JRIIS has resulted in kids choosing careers in nursing and pharmacy programs.

 Potential is aimed at valuing people’s potential, recognizing them, rewarding them and working with leaders to identify rising star.  For example, recognized employees are invited to attend the Grace E. Harris Leadership Institute through VCU, which is a 9-month program for developing leaders.  Also, instead of producing a stuffy annual report, VCUHS recognizes twelve employees each year by telling their stories throughout the report.

 Education is focused on offering formal education opportunities for all employees.  VCUHS pays up to 18 credit hours per year and it is prepaid, not reimbursed.  Further, the organization believe so strongly in the value of education that the program is not limited to just VCU Health employees, but also to their spouses and dependents.  In fact, Debbie earned both of her graduate degrees under this program.  To make it even easier for employees to earn their degrees, management will change and consider alternative work schedules.

 Debbie believes the H.O.P.E. initiative has changed the work environment significantly as VCUHS has received many awards such as Employer of Choice and Best Places to Work.  Because employees the incredible support from their employer, they feel more loyal.  So while employees are hard at work, they know that their employer is trying to make the rest of their life needs simpler.  As a result, employees feel more motivated to “give their all to the patients.” 

 Kristin Druhot, Nurse Practitioner, and mother of three, has relied on several work-life benefits offered by VCUHS to help her successfully manage her personal and professional lives. This includes a flexible work schedule where she works four nine-hour days, leaving the other four hours “flexible.” She can work those four hours whenever her schedule allows–either from home or from the office.

 Financially, the impact of the program has been huge in terms of retention of employees.  In fact, VCUHS research indicated that during the past five years, their turnover rate has reduced by four percent and they attribute this decrease largely to their rich benefits and work/life programs and offerings.  Furthermore, they have experienced an increase in the number of qualified job applicants and overall employee engagement has increased.

 For the future, Debbie says that they look at the HOPE program every year and will add to the more than 400 programs in place already.  Some things under consideration include offering Relay Food services, Wellness for the family, expanding elder care services, backup child care and homework assistance for employees with school age children.

 After Debbie won the award she did not take off for Disney World, instead she decided to figure out a way to give back.  She would love to offer her expertise to other organization in the community who want to learn how to offer similar programs in their companies.  She can speak to logistics, costs, partnerships etc.  She wants to conduct more research to stay at the forefront of what the future may hold for our workforce and figure out how to continue to attract and retain engage employees.  If you are interested in an onsite complimentary consultation with Debbie, please contact her directly at dslayden@mcvh-vcu.edu.

 Debbie’s advice for future applicants of the HR Strategist Award is to continually think about how to partner with your CEO and business leaders to see what they need and lead them into the future.  Be prepared with specific action items and costs and estimated return.  “Don’t worry about the past and just focus on the future”, recommends Slayden.

Genevieve Roberts

Partner, Titan Group LLC

804.934.8334

genevieve@titanhr.com

Genevieve Roberts, Partner

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ESOP Alert: Halloween Leftovers

Background.  As world markets are roiled by a Euro-reality show (Greece is about the size of Alabama with an economy that is less than that of the Dallas-Fort Worth metro area), I have been looking at several issues, including the “typical” contribution rate to an ESOP and the prevalence of equity grants to executives. Along those lines, here are two interesting items about ESOPs here at home.

ESOP as Retirement Vehicle. Principal Financial Group reports that ESOP companies have higher-than-average contribution rates to defined contribution plans, with an average rate of 11.9% of compensation. An especially interesting finding is that ESOP participants are more likely to contribute to a 401(k) plan than are employees in non-ESOP companies. Principal observes that the participation rate in the 401(k) plans for ESOP companies is 63.1% while the average participation in a 401(k) plan is 60.2%.” The report represents data from 37,000 plans and 3.7 million participants.

Equity as Compensation.  The NCEO recently has completed a survey of equity compensation practices in private companies. As it pertains to executive compensation, some highlights include:

 Forty-seven percent of the respondents use an outside appraiser to establish value for this purpose. The next most common response was to have the board set the figure with advice from an outside professional (20%).
 Almost all the companies give equity to at least some of their top executives; 77% of companies give equity to all of these employees.
 Two-thirds of the companies use stock options, with restricted stock being used by 29%. Phantom stock, stock appreciation rights, and restricted stock units are all used by less than 10% of the companies. The average percentage of equity held by non-founders through compensation awards was 15%.
These results were based on completed surveys from 201 companies and 32 service providers representing a broad range of entrepreneurial companies and not merely high-tech or pre-IPO companies.

Conclusion.  These revelations have no global import, but demonstrate that ESOP companies can have a powerful impact on their employees and executives.

 

Bob Musick, Titan Group LLC

Robert L. Musick, Jr. (804) 249-6027 bmusick@titanhr.com

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