Winning with Titan

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. 

Robert L. Musick, Jr.                                 Richard Deutsch

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

bmusick@titanhr.com                                rdeutsch@titanhr.com

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.

Robert L. Musick, Jr.                                     Richard Deutsch

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

bmusick@titanhr.com                                   rdeutsch@titanhr.com

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

Titan Group LLC

Partner

lee@titanhr.com

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

804.754.8330

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

Titan Group LLC

804.754.8330