executive compensation in the say-on-pay era: winning the shareholder value
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© 2011 Towers Watson. All rights reserved.
Executive Compensation in the Say-on-Pay EraWinning the Shareholder Vote — Without Losing the Election
Presenters: Doug Friske, James Kroll, Steven Seelig, Olivia Wakefield
April 7, 2011
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Today’s experts
Doug Friske is the global leader of Towers Watson's Executive Compensation business and is based in Chicago. He has more than 20 years’ experience advising a wide range of organizations on all aspects of executive compensation.
James Kroll is a senior consultant in Towers Watson’s Executive Compensation practice, based in New York. He specializes in corporate governance and executive compensation issues and assists clients with shareholder approval of equity plans, advisory votes on executive pay and other compensation-related governance issues.
Steve Seelig is the executive compensation counsel for Towers Watson’s Research and Information Center in Washington, D.C. His expertise includes the taxation, accounting and legal implications (including SEC disclosure requirements) of all forms of executive compensation and perquisite programs.
Olivia Wakefield is a senior consultant in Towers Watson’s Executive Compensation practice, based in Boston. Specializing in executive compensation programs, she advises clients on topics such as annual and long-term incentive performance metric calibration and plan design, equity pool management and corporate governance.
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Current context: Business performance has bounced back to pre-recession levels
0
200
400
600
800
1,000
1,200
1,400
1,600
1/08 3/08 5/08 7/08 9/08 11/08 1/09 3/09 5/09 7/09 9/09 11/09 1/10 3/10 5/10 7/10 9/10 11/10
S&P 500 Composite
-400
-200
0
200
400
600
800
Q1Y08 Q2Y08 Q3Y08 Q4Y08 Q1Y09 Q2Y09 Q3Y09 Q4Y09 Q1Y10 Q2Y10 Q3Y10 Q4Y10
Cash Flow
Net Income
Net Income and Cash Flow
Source: Standard and Poor’s Compustat® database.
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So, what are we seeing as the say-on-pay era unfolds?
Evidence that contemporary pay practices have largely worked….Overwhelming support for pay plans for most companies in the current say-on-pay cycle (at least so far)Pay levels that have returned to mid-2000 levelsIncentive designs that are essentially unchanged in recent yearsContinued correlation between pay and performance
…although companies are continuing to refine their approachesPush back on “poor” pay practicesMore complete and thoughtful disclosureOngoing debate regarding the rigor in goal setting and the role of explicit performance conditions for long-term incentives
It appears that most companies are getting it right, but with shareholders and other constituents paying close attention, the situation can change quickly
and there’s no room for complacence
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Now we’ll take a look at where we’ve been — and where we’re headed
Topic PresenterRecent Trends in Pay Levels and Practices: The Tale of the Proxies Olivia Wakefield
What We Know About Say-on-Pay Votes, So Far James Kroll
What’s on the Regulatory Horizon? Steve Seelig
Wrap-up and Q&A Doug Friske
Recent Trends in Pay Levels and PracticesThe Tale of the Proxies
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The sample…
170 Fortune 1000 companies holding annual meetings on or after January 21, 2011 (deadline for required say-on-pay votes under Dodd-Frank) that filed proxies by late March
CEOs (principal executive officers) in the role for the past 36 months
Annual Revenue*
Market Capitalization*
25th Percentile $3,000 $2,80050th Percentile $6,500 $7,90075th Percentile $13,500 $18,200
*In millions of dollars.Source: Standard and Poor’s Compustat® database.
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2010 pay levels clearly reflect companies’ improving performance
Pay Element Includes2009 Median
Change2010 Median
ChangeBase salary Annual salary 0% 3%
Total cash compensation (TCC)
Base + bonus (discretionary) + short-term non-equity incentive compensation
3% 17%
Total direct compensation (TDC)
TCC + grant date value for stock options, restricted stock and performance plans
-1% 9%
Source: Towers Watson Executive Compensation Resources.
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The total pay mix really hasn’t changed that much
Source: Towers Watson Executive Compensation Resources.
BaseBonusStock OptionsRestricted StockPerformance Plans
22% 19%
14%
23%
22%
2008
41% Cash
59% LTI
20% 21%
15%
22%
22%
2009
43% Cash
57% LTI
24% 19%
15%
19%
23%
2010
42% Cash
58% LTI
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What has changed is the long-term incentive mix
Companies may be reacting to the recent volatility in the market and are less comfortable using as many options
Source: Towers Watson Executive Compensation Resources.
Stock OptionsRestricted StockPerformance Plans
39%37%
24%
2008
38%36%
26%
2009
33%41%
26%
2010
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Prevalence of performance measures in long-term incentive plans remained fairly constant…
Prevalence of Long-Term Incentive Performance Measures
Source: Towers Watson Executive Compensation Resources.
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Cash Flow
ROE
Other Non-Financial
Revenue
ROC/ROIC
Operating Income/Margin
TSR
EPS/Net Income
201020092008
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…as have annual plan measures for the most part…
Prevalence of Annual Incentive Plan Measures
0% 10% 20% 30% 40% 50% 60% 70%
ROE
ROC/ROIC
Cash Flow
Operating/Strategic
Revenue
Business Unit Performance
Operating Income/Margin
Individual Performance
EPS/Net Income
201020092008
Source: Towers Watson Executive Compensation Resources.
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…although a number of companies made adjustments in 2010
For annual plansA quarter (25%) of companies changed the performance measures used for 2010 annual awards from those used in 2009
For LTI plansAlmost as many (24%) changed performance goals used for 2010 LTIawards
Source: Towers Watson Executive Compensation Resources.
Bottom line: Many companies continue to fine-tune their programs to try to get it right
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The distribution of CEO bonuses is back to pre-crisis levels…
Source: Towers Watson Executive Compensation Resources.
Percent of CEOs Receiving an Actual Bonus That is…
0% 5% 10% 15% 20% 25% 30% 35% 40%
>200% of target
>150% – 200% of target
>100% – 150% of target
>50% – 100% of target
<50% of target
0%
20072008
20092010
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…and the alignment with performance continues to be strong
Tota
l Dire
ct C
ompe
nsat
ion
Total Shareholder Returns
Belo
w M
arke
tAb
ove
Mar
ket
Above IndustryBelow Industry
15%
17%
68%
2008
Tota
l Dire
ct C
ompe
nsat
ion
Total Shareholder Returns
Belo
w M
arke
tAb
ove
Mar
ket
Above IndustryBelow Industry
12%
12%
76%
2009
Tota
l Dire
ct C
ompe
nsat
ion
Total Shareholder Returns
Belo
w M
arke
tAb
ove
Mar
ket
Above IndustryBelow Industry
18%
16%
66%
2010
Source: Towers Watson Executive Compensation Resources.
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We also saw a close correlation between investor returns and the value of LTI granted that the CEO realizes
Three-year TSR (2008 to 2010)
LTI Realized/ LTI Granted*
Top-third TSR performance 33% 118%Middle-third TSR performance -1% 89%Bottom-third TSR performance -34% 49%
*Values include equity awarded to CEOs in fiscal years 2008, 2009 and 2010.Source: Towers Watson Executive Compensation Resources; Standard and Poor’s Compustat® database.
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Companies made more one-time grants in 2010
Almost a third (29%) of companies made one-time and/or retention grants in 2010, compared to 16% in 2009
In both years, the great majority of these grants were time-based
Source: Towers Watson Executive Compensation Resources.
2009
Companies Making One-Time and/or Retention Grants
16%
84%
One-time or retention grants madeNo grants made
2010
29%
71%
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Finally, our review found many changes in CD&As
They are longerAverage length increased by 7%
Executive summaries are now the rageHalf (50%) of companies added an executive summary during 2011, so that a majority (64%) of companies now include one
Disclosures of annual plan goals improvedFully 85% of companies disclosed the specific performance goals for the 2010 plan yearMore than three-quarters (78%) of companies showed actual performance attained for 2010 to support the bonus paid
Source: Towers Watson Executive Compensation Resources.
What We Know About Say-on-Pay Votes, So Far
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Key observations to date
Overall, we’re seeing strong support for most companies’ proposals, similar to last proxy season
Proxy advisors and some shareholders acknowledge that “outliers” will come in for added scrutiny
The circumstances behind negative votes and company responses are highly situational
No one approach will work for all companies
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Early say-on-pay votes show most companies are receiving strong shareholder support…
2.7% 1.4% 2.0%5.5%
13.7%
74.7%
0%
20%
40%
60%
80%
Below 50% 50% – 59.9% 60% – 69.9% 70% – 79.9% 80% – 89.9% 90%+
Distribution of Support for Say-on-Pay Proposals: 2011*Percentage of Companies in
Support Range
*Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.
Support for Say-on-Pay Proposal
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…but a negative ISS vote recommendation has an impact
The 14% of companies receiving negative Institutional Shareholder Services (ISS) vote recommendations have received above-average opposition from shareholders
Four companies have failed to get majority support for their say-on-pay proposals
On average, only about 46% of shareholders at each of these companies voted in favor of the say-on-pay proposalISS recommended votes against these proposals, citing such concerns as a pay-for-performance “disconnect” or change-in-control provisions containing tax gross-ups
ISS Vote Recommendation
Number of Companies
Votes in Favor
For 126 94%
Against 20 71%
Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.
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Subpar TSR performance doesn’t necessarily result in a negative ISS vote recommendation
Almost a third (29%) of companies failed both the one- and three-year TSR test
Yet ISS recommended votes in favor of say-on-pay at more than two-thirds (68%) of these companies
18%9%
23%
50%
ISS Say-on-Pay Vote Recommendations for Companies With Below-Median TSR
ISS support despite pay-for-performance concernISS support, other factors (e.g., pay decrease, new CEO)ISS negative, pay-for-performance concernISS negative, other concern
Positive recommendations (68%)
Negative recommendations
(32%)
Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.
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Say when on pay: After an early push for triennial, annual votes gain steam
Three quarters (76%) of companies have seen annual vote frequency receive majority support
Only one-third (33%) of companies recommending triennial votes received majority support
Original Frequency Recommendation
Companies Recommending
Frequency
Frequency Implemented Frequency Decision PendingAnnual Biennial Triennial
Annual 49 20 None None 29
Biennial 9 3 1 None 5
Triennial 80 20 None 14 46
None 8 3 None None 5
Total 146 46 1 14 85
Implementation of Say-on-Pay Vote Frequency
Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.
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After say-on-pay, now what? Some next steps to consider
Define the vote outcome you want to see
Review proxy advisor reports for accuracy
Determine what additional information will help you gain greatershareholder support
Assess the influence of proxy advisor vote recommendations
Determine who will represent the company in the shareholder engagement process and the timing of outreach efforts
What’s on the Regulatory Horizon?
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One set of Dodd-Frank enabling regulations was released in late March…
Exchange Listing Requirements — “Independence”
Disclosure of “Conflicts of Interest”
Who Compensation consultants, lawyers and other advisors to the compensation committee
Compensation consultants
What Factors in evaluating independence:
1. Other services provided by the advisor’s firm
2. Fees as a percentage of firm revenue3. Policies and procedures to prevent
conflicts of interest4. Other business or personal
relationships with compensation committee members
5. Company stock owned
Proxy disclosure expanded to address:
Whether the work of the compensation consultant raised any conflict of interestand, if so, the nature of the conflict and how it was addressed
How the five factors influenced the committee’s conclusion
A second set of proposed regulations addresses the independence of compensation committee members
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…while we await others later in 2011
How will pay be measured? What is the time period required?How will performance be measured — only TSR?Will this be in place for the 2012 proxy?
Disclosure of pay for performance 1
Disclosure of CEO pay versus median employee pay2Repeal legislation has been introduced in the HouseSEC officials have testified to Congress that there is little leeway because the statute requires median rather than average compensation
Clawbacks of compensation paid based on misstated financial results3Can discretion be exercised in enforcing the clawback?Would existing contracts be grandfathered? How is incentive compensation defined? Would the SEC regulate indemnity clauses?
Source: Towers Watson Executive Compensation Resources analysis as of April 4, 2011.
Wrap-up and Q&A
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Where do we go from here?
Get behind the say-on-pay vote totalsEven if your 2011 vote was highly favorable, things can change year to year depending on performance and payUnderstand the input from shareholders and proxy advisors
Stay committed to your principles and practices — you don’t need to conform to have a successful program or shareholder vote
Understand the value and implications of outstanding incentivesSignificant value created the past few years, given market volatilityInfluences expectations, with big vesting cliff likely on the horizon
Fine-tune your thinking in advance of the next round of SEC rule making
Consider potential pay-for-performance rationalization and disclosure
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Questions?
Watch for our soon-to-be-launched blog, Executive Pay Matters, for ongoing updates and information
on the latest trends and emerging issues in executive pay