Mark Gilbert Has Forgotten the Meaning of Capitalism

On Bloomberg, Mark Gilbert asks:

Should the investment arm of one sovereign nation be using its financial muscle to influence salary policies in other sovereign nations, setting principles which then guide how it votes in particular examples?

It isn’t surprising that he gets the wrong answer, calling the sovereign wealth fund’s votes against excessive compensation “mission creep.” He’s asking the wrong question. It should be: “Should a major shareholders who is a sophisticated institutional investor have the right to exercise its independent judgement on matters legally required to be put to a shareholder vote?”

The answer is yes. That is what capitalism means. A provider of capital has certain rights granted to ensure confidence in the markets through transparency, accountability, and structural limits on conflicts of interest. To put it another way, who is in a better position to evaluate CEO pay, the board members selected by, paid by, and informed by the CEO him or herself or a fiduciary shareholder obligated to deploy its resources to maximize returns for its beneficial owners?

Gilbert presents no evidence that these actions are taken for any reason other than the creation of shareholder value, a case he cannot make for the design of most CEO pay plans. On the contrary, he quotes the fund’s policy approvingly, noting that

it would back remuneration policies that are “driven by long-term value creation and aligns CEO and shareholder interests.” Pay packages should be transparent, pension entitlements should be only “a minor part” of total packages, while a “substantial proportion” should be in the form of equity that’s locked in for “at least five and preferably 10 years.”

His objection is Norges’ conclusion that its efforts should “moderate pay levels in the longer term.” Of course, he has no basis for arguing that this goal, even if achieved, would be anything other than beneficial to shareholders.

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.”

FT: Investors pass the buck on governance VEA: No They Don’t

Rana Foroohar’s column on institutional investors and corporate governance is internally inconsistent and factually wrong. She says that institutional investors “outsource” their proxy votes to the proxy advisory firms. But anyone who understands finance and markets has to recognize that (1) institutional investors rely on a wide range of sources for making all investment decisions, including proxy voting, and that they make decisions about the sources they rely on based entirely on their assessment of value, (2) the data show that institutional investors like the analysis of the proxy advisory firms but often depart from their recommendations, especially on complex and controversial votes like proxy contests and business combinations, and (3) the votes she focuses on, regarding CEO pay, are advisory only and can be disregarded by the board

In other words, even if they do “outsource” their fiduciary obligation (no evidence this is the case), the vote is not binding on the company, which can ignore it.

She writes:

Consider the recent saga of Credit Suisse. Over the past couple of years, the company has been trying to orchestrate a turnround, settling a big fine over dicey (pre-financial crisis) mortgage-backed-security deals with the Department of Justice, offloading bad assets and restructuring the business. None of this is good for share price in the short term, but it was necessary. No surprise, then, that the Credit Suisse management team was disappointed when proxy advisers opposed its corporate pay plan, citing 2016 losses, despite the fact that the top brass took a 40 per cent cut in its own compensation as part of the turnaround effort. “It was just totally demotivating for staff and management,” says one insider. “We could have left these decisions for someone else to worry about later and there would have been no issue over pay.”

ISS stands by its recommendation, and adds that it does take into account other performance metrics, like return on invested assets, revenue growth, and so on. But TSR is “what investors want to see,” says Patrick McGurn, special counsel at ISS, and therefore determines a yes-or-no vote on pay. “We’ve talked to our clients about using non-financial performance to judge pay, but they want something quantifiable. You can’t just have some vague judgment about it.”

A couple of points here. First, Foroohar completely undercut her own argument by showing that it is the institutional investors and proxy advisory service clients who tell ISS what to do, not the other way around. Second, if, indeed, the turnaround will provide benefits to investors, that is when the benefits should be realized by the employees as well, and there are pay plans that provide all the right incentives to do so.

Source: Investors pass the buck on governance

PWC: Climate Change of More Concern to Investors than to Corporate Directors | HuffPost

VEA Vice Chair Nell Minow interviewed PwC’s Paula Loop for the Huffington Post:

A report released on October 17, 2017 from PwC finds that on some subjects there is a wide disparity between the directors who oversee corporate strategy and the investors to whom they owe the legal duties of care and loyalty. These findings are reflected in the title of the report, issued by PwC’s Governance Insights Center, The governance divide: Boards and investors in a shifting world.

The report concludes that “directors are clearly out of step with investor priorities in some critical areas,” especially with regard to climate change and sustainability and board composition. “I definitely think there is a gap,” said Paula Loop, who leads the Governance Insights Center. “There are some areas where we made some improvements, where we’ve done some bridging of the gaps but there are some areas where the gap has widened as well.”

The report revealed some surprising dissatisfaction by board members with their fellow directors. There is a significant increase with now 46 percent of the more than 800 corporate directors who responded to the survey admitting that at least one of their fellow directors should not be on the board. The reasons for dissatisfaction were evenly divided between five different categories: overstepping boundaries with management, lack of appropriate skills/expertise, ability diminished by age, reluctance to challenge management, and an “interaction style” that “negatively affects board dynamics.” Loop said, “It gets back to having a board assessment process and to really think about refreshment of the boards. We try to do the follow up discussion: How do you provide feedback to board members? Why haven’t you addressed this issue? Why is it that your board can’t do the right thing to make sure you have the right people on the board or provide coaching to the people on the board that you don’t think are doing a good job? It really gets back to board leadership.”

She noted that board quality is also a significant priority for shareholders. “Something that institutional investors have been talking quite a bit about is board composition, making sure you have the right people in the boardroom. Investors want to understand what your skills matrix is, what are the different things these individuals bring to the room and whether or not you are doing some kind of an assessment process.” She pointed to the New York City Comptroller’s Board Accountability 2.0 project, with Scott Stringer and the $192 billion New York City Pension funds asking for better board diversity, independence, and climate expertise.

But while institutional investors like pension funds raise concerns about board diversity, 24 percent of directors said that they didn’t think that racial diversity was a priority in board composition. Loop said, “We asked whether or not they thought that age diversity was important in the boardroom and 37 percent of them told us that they thought that age diversity was very important. Interestingly enough, 52 percent said they already have it. But in the S&P 500 only four percent of the directors are under the age of 50. So you do wonder, what’s their definition of age diversity?” The report’s findings on gender diversity show little progress. “All but six companies in the S&P 500 have at least one woman on their board, and 76 percent of those have at least two women. But only 25 percent have more than two women, and gender parity is rare. Only 23 companies in the Russell 3000 have boards comprised of 50 percent or more women.” Unsurprisingly, the report found that women directors thought efforts for diversity were moving too slowly, while the male directors thought there was too much focus on diversity.

For me, the most surprising finding was the overwhelming majority of directors who said their board did not need sustainability or climate change expertise. The core priority directors should have is sustainable growth, and it is impossible to do that without directors who are familiar with all aspects of sustainability, from the supply chain to the company’s reputation, technology, and product development. But investors and directors in agreement on the importance of cybersecurity expertise as a board priority. Loop said that many directors acknowledged this as an area where they need to spend more time and get more expert guidance. Only 19 percent said they had enough already.

And on the ever-popular topic of CEO pay, the report found that 70 percent of directors believe that executives are generally overpaid, although they are themselves responsible for it. Perhaps that is the most telling finding of all.

Source: PWC: Climate Change of More Concern to Investors than to Corporate Directors | HuffPost

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).

When a Company Is Profiting From the Opioid Crisis – The Atlantic

On July 26, at the annual shareholder meeting of McKesson, the nation’s largest distributor of pharmaceuticals, including opioid drugs, shareholders refused to approve the company’s generous executive-compensation plan after the International Brotherhood of Teamsters—which holds stock in McKesson—campaigned against it, citing the company’s “role in fueling the prescription opioid epidemic.” McKesson rejected that characterization, and denied that it had any such role. Calling the opioid, heroin, and fentanyl epidemic “complicated,” Jennifer Nelson, a spokesperson for McKesson, told me that “in our view, it is not to be laid at the feet of distributors.” The Teamsters, she charged, were trying to use the addiction crisis to their advantage in their ongoing labor dispute with the company involving the union’s efforts to represent workers at a McKesson distribution center in Florida.<P><P>The shareholder vote, which isn’t binding—McKesson says it’s still reviewing its current compensation plan—may seem like a minor slap over an esoteric bit of corporate governance, but it was a notable exception among public companies. According to the consulting firm Compensation Advisory Partners, of 447 say-on-pay votes among S&P 500 companies this year before early August, only five, including McKesson, suffered rejection. The Teamsters view the outcome as a success, especially at a time when unions’ power has waned. “Unions have been pushing for years for standard good-governance practices” in companies, says Michael Pryce-Jones, the union’s senior governance analyst. “This has importance across political divides.”

Source: When a Company Is Profiting From the Opioid Crisis – The Atlantic

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