Performance-Based Compensation May “Die” Under the Tax Cut Legislation

An amusing but telling “obituary” for performance-based compensation by Dan Walter outlines the consequences of doing away with the tax benefits for pay linked to stock price increases.

The proposed tax reform bill of 2017 would eliminate many of the time-tested and successful components of equity compensation, effectively removing one of the three legs of many companies’ three-legged stool of compensation philosophy.

Under the proposed rules:

Appreciation vehicles such as stock options and SARs would be taxed at vesting, instead of at the time of exercise. This would effectively shorten their useful lives from potentially 10 years to perhaps 4 or 5 years. It would also make the use of these tools for pre-IPO or other illiquid companies too risky to be a recommended practice.

Full value vehicles like RSUs, would be taxed much as they are today, but with far less flexibility in deferring income or linking vesting to performance conditions.

Performance vested awards would be taxed immediately, instead of at the time of performance achievement and associated vesting. While these are currently investors’ preferred tool for executive long-term incentives, the change in taxation would make them a punitive form of pay beginning in 2018.

It appears that all outstanding equity would be subject to these rules as of January 1, 2018. This would result in changes for both companies and employees that would include the death of long-term motivation and retention tools, immediate taxation for employees, acceleration of expense associated with all equity-based incentives and much, much more.

Presumably, cash bonuses tied to financial metrics or other performance goals would still be available.

Gretchen Morgenson: 20 Years of Corporate Governance

In her last column for the New York Times, Gretchen Morgenson summarizes the best and worst and most improved of the corporate governance issues she has reported on, quoting VEA Vice Chair Nell Minow:

Nell Minow is a corporate governance expert and vice chairwoman at ValueEdge Advisors, a firm that guides institutional shareholders on reducing risk in their portfolios. She has been rattling cages in the governance field since the mid-1980s and says she’s seen a definite improvement in boardroom makeup and practices.

“When I started in this field, O. J. Simpson was on five boards, including the audit committee of Infinity Broadcasting,” she recalled in an interview. “And at another company, the C.E.O.’s father was on the compensation committee. We’ve come a long way.”

That’s not to say that problems arising from sleepy and clubby boards have been eradicated. “Exhibit A is executive compensation,” Ms. Minow said. “The first C.E.O. pay package I ever complained about was $11 million. The very fact that that has gone completely berserk shows that boards are still a long way from where they should be.”

Do Performance Share Units Work?

Aubrey E. Bout and Blaine Martin of Pay Governance evaluate the effectiveness of a decade of performance stock units on shareholder value.

PSU plan payouts in aggregate were aligned with company total shareholder return (TSR): plans paying out above target showed significantly higher TSR than plans paying out below target during the same period.

There is no one-size-fits-all approach to pay-for-performance: PSU plans using both operating metrics and relative TSR metrics show strong alignment with TSR over the contemporaneous period.

We found that PSU payouts for plans implemented in and after the first year of say-on-pay (SOP) had higher payouts than plans before SOP, but this trend is likely influenced by broad stock market trends independent of SOP.

PSU plans based entirely on operating metrics had median plan payouts at or below plans that included Relative TSR metrics in 7 of 10 years reviewed. This finding suggests that Compensation Committees closely scrutinize goal setting when using operating metrics in PSU plans, which rebuts arguments that companies commonly set easy operating financial goals to get above-target payouts.

KB Home to Cut C.E.O.’s Bonus After His Rant Against Kathy Griffin – The New York Times

The New York Times also notes other recent examples of executives whose comments were deemed to hurt the company’s brand or reputation.

Engaging in problematic activity has forced several chief executives from their jobs.

■ Brian J. Dunn of Best Buy had a relationship with an employee (2012)

■ Matt Harrigan of PacketSled ranted on social media on election night about killing President-elect Trump (2016)

■ Scott Thompson of Yahoo was found to have padded his résumé (2012)

■ Kenneth Melani of Highmark got into a fight with the husband of his then-girlfriend, who was also an employee (2012)

■ Brendan Eich of Mozilla donated $1,000 in support of a ballot measure to ban same-sex marriage, causing outrage in Silicon Valley (2014)

■ Klaus Kleinfeld of Arconic wrote to a hedge fund manager without the board’s knowledge (2017).

Firms facing revolt over executive pay to be named on public register | Business | The Guardian

A new register naming firms that find themselves under shareholder pressure over executive pay is to be launched later this year as part of government plans aimed at curbing boardroom excess and increasing transparency.In what was described by the government as a world first, the new register will name firms where a fifth of investors have objected to proposed executive annual pay packages.

However, the unveiling of the policy marks a retreat from the much more radical approach which had originally been touted by Theresa May in the form of promises to increase the frequency of binding shareholder votes on corporate pay policies. The policies of listed British companies are currently subject to a binding vote every three years.

Source: Firms facing revolt over executive pay to be named on public register | Business | The Guardian

Investors fear use of clever accounting to trip bonuses

Large investors fear FTSE 100 companies are using clever accounting techniques to trigger high executive bonuses and mask poor financial performance.The concerns come as research shows the difference between stated and adjusted operating profits for the UK’s top-100 quoted companies is at 51 per cent — the widest gap in a decade. In 2007 the split was just 15 per cent.

Russ Mould, investment director at AJ Bell, the investment company that carried out the research, said the figures suggested equity markets were nearing “the top of a cycle”.

“As growth gets harder to generate, there is a temptation to employ different financial tactics to generate it, either to appease return-hungry shareholders or hit bonus triggers,” he said.

“If a share price suddenly turns and the economic cycle turns with it, investors [will be left] wondering why something that looked like a sound investment on paper is now a terrible one in reality.”

The growing use of revised profit figures have made shareholders and analysts increasingly wary of these numbers, according to Andrew Millington, head of UK equities at Standard Life Investments, one of Britain’s largest fund companies….

David McCann, an analyst at brokerage Numis, said more companies were reporting adjusted profit figures as “it is becoming harder to deliver growth in a low return environment”.“Companies are looking for ways of showing optical growth so they don’t have to report declining results. Manager pay is increasingly being linked to earnings-based measures, so there is increasing motivation to boost those measures,” he said.

Source: Investors fear use of clever accounting to trip bonuses

Rising Angst Among Defenders of Overpaid CEOs – Inequality.org

Getting rid of the new pay ratio disclosure requirement scheduled to take effect next proxy season may be harder than the Trump administration thought.  I was particularly heartened by this article’s reporting on the number of comments in favor of the proposal (and how that avalanche of comments makes it harder to rescind the rule).  And I was particularly amused by the Chamber of Commerce’s desperation ploy when it’s usual “burdensome” argument failed.  It’s next attempt was claiming that people might actually use those disclosures to make policy.  Uh, that’s the point of information and data, right?

Overpaid CEOs enjoyed a sweet victory in June when the House of Representatives took action to protect them from having to disclose how much more money they make than their workers.But the celebration didn’t last long. The odds of the Senate taking similar action any time soon were always long. Now, given the health care quagmire, these odds are even longer.

Source: Rising Angst Among Defenders of Overpaid CEOs – Inequality.org

CEOs Cut Investment To Sell Their Own Shares At High Prices – Alex Edmans

A new look at “short-termism” examines the link between vesting of the CEO’s shares and reduced growth rate in investment, suggesting an inverse correlation between what’s best for the CEO and what’s best for shareholders.

Rather than studying the shares that the CEO actually sells, we study the amount of shares that are scheduled to vest. For example, if a CEO was given a chunk of shares in Q3 2012, with a 5-year vesting period, they first become saleable in Q3 2017. CEOs typically sell a large portion of their shares when they vest, to diversify their portfolio (we verify this in the data). Thus, if the CEO knows that her shares will be vesting in Q3 2017, and so she’s likely to sell a large portion, she has incentives to cut Q3 2017 investment. Importantly, the driver of Q3 2017 vesting equity is the decision to grant the CEO shares back in Q3 2012. That was five years ago, and so is likely exogenous to (not driven by) Q3 2017 investment opportunities. Thus, any correlation between Q3 vesting equity and Q3 investment cuts is likely to be causal.

We include both shares and options in our measure of vesting equity and estimate this amount at the quarterly level. This is because the highest frequency with which investment is reported is also at the quarterly level. We regressed the change in investment (measured five different ways) on vesting equity and many control variables that may also drive investment cuts (e.g. investment opportunities or financing constraints).

We find a significant negative correlation between vesting equity and the growth rate in investment – using all five investment measures.

Source: CEOs Cut Investment To Sell Their Own Shares At High Prices – Alex Edmans

Rosanna Landis Weaver reviews The CEO Pay Machine 

Our favorite expert on CEO pay, As You Sow’s Rosanna Landis Weaver, likes Steven Clifford’s new book, The CEO Pay Machine: How it Trashes America and How to Stop It.  We recommend the book and Weaver’s review:

Clifford takes apart all the components with a fresh eye. He is skeptical, for example, of the mantra of pay for performance. He notes that bonuses that don’t change behavior are a waste of money, and that many that do change behavior may change it for the worse. “All pay-for-performance systems cause more harm than good,” he writes. “They generate perverse incentives, undeserved and often absurdly high bonuses, and damage the companies that use them.” … He also speaks with great insight about the role of directors. “It’s impractical, if not impossible,” he notes, “for board members committed to being supportive players on the team to transform themselves into hard-nosed negotiators.”

Source: Book Review: The CEO Pay Machine – CEO Pay Updates: 2017 Proxy Season

Opioid Controversy: McKesson CEO’s Bonus Draws Shareholder Ire | Fortune.com

The Teamsters pension fund has written to shareholders about excessive compensation at McKesson: “It is staggering that Hammergren received a $1.1 million boost to his bonus just months after the company announced it had reached a record $150 million settlement with the DEA in a year the company faces mounting litigation, negative press and Congressional scrutiny.”

[John] Hammergren is consistently one of America’s highest-paid executives, and as such, his compensation has been scrutinized and pilloried over the years—in 2013, shareholders overwhelmingly said no to his pay package (something shareholders rarely ever do). But this year, a considerable amount of outrage over the CEO’s compensation is focused on a $1.1 million slice of his $97.6 million compensation pie—and that outrage is closely related to the country’s spiraling opioid crisis.The $1.1 million is the amount the McKesson board’s compensation committee boosted Hammergren’s annual bonus pay this year—a cherry on top of all that other cash—through the use of an “individual performance modifier,” an assessment that incorporates a range of non-financial metrics including alignment with the company’s much touted “ICARE” principles—Integrity, Customer first, Accountability, Respect, and Excellence. Good behavior, in essence.

The thing is, as Fortune reported in a feature story in June, the company’s behavior hasn’t been so good. McKesson (MCK, +0.98%) is currently embroiled in controversy around its role in the opioid epidemic; in January, the company settled, for a record $150 million, claims that it had failed to report large numbers of suspicious orders of prescription opioids to the DEA. As a result, McKesson, which accepted some responsibility in the federal settlement, will operate under an independent monitor for the next five years. Meanwhile, in West Virginia—where it shipped more than 100 million doses of highly addictive prescription pain pills in a period of six years—the state Attorney General has sued the company for violating the state’s controlled substances and consumer protection laws, and McKesson faces litigation brought by towns and counties across the state. Along with the nation’s other two major drug distributors, the company is also subject of a Congressional investigation.McKesson’s testimonials to its purported guiding principles, all the while, is what has really gotten under the skin of some investors who view them as mere lip service.

Source: Opioid Controversy: McKesson CEO’s Bonus Draws Shareholder Ire | Fortune.com