1 Preparing for the 2015 Proxy Season Executive Pay Trends, Regulatory Developments, and Shareholder Advisory Group Policy Update NACD Atlanta Meeting January 21, 2015 CONFIDENTIAL
2 Hot Topics Topic Observations External vs. Internal FactorsCompensation Committees have evolved from focusing on external factors like market competitiveness and proxy advisory firm policies to focusing on internal factors like business and talent strategy alignment Internal factors driving compensation decisions and external factors informing compensation decisions Performance Measures & Goals Compensation Committees are focused on selecting the right performance measures for the business, including both “leading” (value driver) and “lagging” (outcome) metrics Compensation Committees spending more time on goal setting to ensure strong alignment between executive pay and company performance Retention & Succession Planning Improving economic and stock market performance has allowed many executives to realize significant value from equity awards granted in prior years Compensation Committees focused on retaining key executive talent and ensuring strong internal successor candidates Proxy Advisory Firms Proxy advisory firms continue to exert influence on executive compensation matters requiring shareholder approval (e.g., Say on Pay, equity plan proposals, etc.) Compensation Committees want to understand, but not react / automatically accept, advisory firm views Proxy Disclosure Has evolved from compliance to communication to persuasion (e.g., telling a compelling story about how pay program aligns with business strategy and performance, best practices, etc.) Compensation Committees more involved in the process and making sure that the rationale for pay decisions is being clearly articulated Many companies considering and including voluntary disclosures (e.g., realizable pay, P4P graphics, etc.) Shareholder Outreach Significantly more shareholder outreach being conducted, with the key to proactively establish relationships and dialogue before there’s a burning platform need to influence vote outcomes
3 Executive Pay Trends Findings from PM&P’s 2015 Compensation Planning Survey (Public Companies)Top compensation program priorities for 2015 include alignment of pay with business strategy and performance, and executive attraction / retention Lower concerns include: complying with regulatory requirements, preparing for Say on Pay, conducting shareholder outreach, and managing equity plan dilution / share reserves Most public company respondents target executive pay at or above the market 50th percentile Prevalence of companies targeting the 50th percentile increases with company size, reflecting higher levels of external scrutiny Above-market incentive award opportunities are often tied to stretch performance goals to allow for directional alignment
4 Executive Pay Trends Findings from PM&P’s 2015 Compensation Planning Survey (Continued)FY 2015 base salary increases typically expected to range between 2% and 4% 15% expect no increase for the CEO (down from 30% in 2014) 8% expect no increase for CEO direct reports (down from 15%) Most respondents (75%) expect short-term incentive (STI) awards for FY 2014 at or above those earned in 2013 6% expect no payouts for FY 2014 Payouts generally expected to be within a range of + / - 25% of target award levels Respondents evenly split between using similar or higher year over year performance hurdles for FY 2015 STI goals Long-term incentive (LTI) target value mix has been fairly constant over the past 3 years, with nearly half provided through performance shares / cash grants Year over year changes in grant date LTI award values and performance hurdles are closely aligned About half expect LTI grant values and performance hurdles for FY 2015 to be similar to 2014 30% expect higher values and higher performance award hurdles
5 Executive Pay Trends Findings from PM&P’s 2015 Compensation Planning Survey (Continued)Executive perquisites remain a minority practice 5% of respondents plan to or recently discontinued perks SERP prevalence also continues to decline 28% offer Restoration SERPs 8% offer SERPs with income replacement features Many respondents plan to enhance upcoming CD&A disclosures relating to pay decisions, alignment with performance, and shareholder outreach efforts and outcomes Most include Executive Summary; 38% will emphasize realized or realizable pay when assessing alignment with performance
6 Legislative & Regulatory Update Current Status of Dodd Frank Executive Pay ProvisionsTo date, the SEC has issued final rules and effective dates for only three of seven provisions Disclosure of Board Chairman / CEO roles (2011 proxy season) Compensation Consultant Conflict of Interest (2013 proxy season) Compensation Committee Advisor Independence & Oversight; Member Independence (2013 / 2014) While the SEC describes rule making for remaining Dodd Frank provisions as a priority for 2015, any new requirements likely won’t become effective until the 2016 proxy season at the earliest Many companies have already adopted clawback and stock hedging/pledging policies in response to shareholder and advisory group feedback and policies Proxy filings often include exhibits and narratives on the alignment of executive pay and performance Most are taking a “wait and see” approach with regard to CEO pay ratio provision, which is not currently expected to become effective until at least the 2017 proxy season. May be more a media relations than an investor relations issue Pending Provisions Description Internal Equity (CEO Pay Ratio) Disclosure Companies required to disclose ratio between CEO pay (as reported in Summary Compensation Table) and median pay for all other employees, plus applicable methodology used. Company can use “statistical sampling” to determine median employee and any consistently used approach to determine non-CEO pay Clawback Policy Companies must implement and disclose policies for recouping excess payments of incentive-based compensation provided to current and former executive officers during the 3 year period preceding the date of a material financial restatement Pay-for-Performance Disclosure Proxy disclosure of the relationship between compensation actually paid to executives and the company’s financial performance (also taking into consideration total shareholder return) Disclosure of Hedging Policies Proxy disclosure of whether employees and directors are permitted to purchase financial instruments to hedge or offset a decrease in the company’s stock price
7 Legislative & Regulatory Update Shareholder Litigation of Executive PaySay on Pay Claims: since late 2012, class action suits have alleged false, misleading, and/or inadequate disclosure as relates to rationale for pay decisions, use of market benchmarking and peer groups, analyses performed by external advisors, etc. Claims typically made shortly after proxy filing, seeking to enjoin annual shareholders meeting, but can also pertain to Board’s lack of responsiveness to prior negative votes Most cases have been dismissed by courts, although some companies have settled to avoid litigation Future claims may also pertain to CEO pay ratios and applicable disclosures Equity Compensation Plan Claims: typically involve claims of insufficient disclosure relating to rationale for new or amended plan, factors considered by the Board, dilution impact of additional share request, expected duration of share pool, etc. These claims, which also seek to enjoin annual meeting, have also generally been unsuccessful for plaintiffs Section 162(m) Claims: include allegations of unjust enrichment, grants in excess of designated plan limits, false or misleading disclosure relating to 162(m) compliance (e.g., if a company claims to adhere to 162(m) but pays non-deductible compensation) or failure to get plans re-approved by shareholders (every 5 years) Considerations Review all disclosures to ensure compliance with applicable securities laws Avoid definitive statements suggesting executive pay will always be fully tax deductible Get shareholder re-approval of plans subject to 162(m) at least every 5 years Ensure all equity grants comply with plan limits and provisions Provide expanded disclosure, as deemed appropriate, on issues typically included in shareholder lawsuits, such as rationale and expected duration for equity plan proposals, peer group selection process, etc. CONFIDENTIAL
8 Legislative & Regulatory Update Other DevelopmentsPCAOB Risk Oversight: new rule requires auditors to assess potential risk of material misstatements or fraudulent financial reporting resulting from executive compensation programs / arrangements Creates increased pressure to address risk internally and provide more thorough proxy disclosure May lead to increased interaction between auditors and compensation committee members and/or external advisors Proxy Advisory Industry Regulation (SLB 20): SEC guidance reminds investment advisors (IA) that they should not rely on proxy advisor (PA) voting recommendations without actively overseeing PA processes, qualifications, and potential conflicts of interest. Specifically, IAs: Don’t need to vote on every issue (likely would not apply for compensation proposals) Should have their own voting guidelines, and Should exercise due diligence if relying on proxy advisory services / recommendations May eventually limit the influence of proxy advisory firms such as ISS and Glass Lewis In response to guidance, companies should consider: Reviewing voting authority policies with IAs Requesting pre-publication reports from PAs, and Highlighting any errors with IAs and PAs CONFIDENTIAL
9 Legislative & Regulatory Update Other Developments (Continued)Non-Employee Director Compensation Litigation: some cases alleging excessive compensation have been allowed to proceed, since directors generally approve their own compensation and are not treated as “disinterested” parties protected by the business judgment rule Some cases have focused more on cash compensation, with claims involving equity grants dismissed because they were made under shareholder approved plans (e.g., Unilife Corp) Several claims pertaining to equity grants under shareholder approved plans have been allowed to proceed, since plans (especially those containing very large caps on maximum awards) were determined to allow directors too much discretion in determining grant levels (e.g., Facebook, Republic Services) May result in more companies establishing annual grant limits for non-employee directors within equity compensation plans Republican-Controlled Congress: decreases the probability of passage of outstanding legislative proposals that would adversely impact executive compensation (e.g., reduction/elimination of 162(m) deductions, favorable tax treatment for ISOs, etc.) For example, Republicans already said they won’t pass proposed CEO Employee Pay Fairness Act (limiting annual executive pay tax deduction to $1 million per person unless wages increase for lower-paid employees) Repeal of Dodd-Frank Act provisions is unlikely in the near term under the currently divided government CONFIDENTIAL
10 SOP and Shareholder Advisory Group Policies Institutional Shareholder Services (ISS) Impact on Say on Pay ISS recommendation often has a material impact on Say on Pay (SOP) shareholder support levels: 98% of companies pass SOP votes, with average support of 90% ISS recommended against 11% of SOP proposals, while failure rate is only 2% 8% - 9% of companies have received < 70% support, the level which triggers greater scrutiny from ISS and expectation of enhanced shareholder outreach and Compensation Committee responsiveness Spread for shareholder support level for companies receiving ISS “Against” recommendation is ~ 25% lower than for those receiving “For” recommendation Many believe SOP is more a vote on performance (e.g., total shareholder return) than on pay CONFIDENTIAL
11 SOP and Shareholder Advisory Group Policies 2015 Policy Updates for Executive Compensation Impacting SOP Recommendations ISS Quantitative “Pay for Performance” tests: Russell 3000E companies (~ 4,000 companies, including some micro caps) now subject to Relative Degree of Alignment (RDA) and Multiple of Median (MOM) analyses Triggering scores for “concern” levels also changed as follows: Hurdle lowered for RDA test and raised for PTA test; changes may impact voting recommendations for some companies Glass Lewis (GL) “One-off” or supplemental awards will receive additional scrutiny and may adversely impact voting recommendations, as GL believes they may “undermine the integrity” of the compensation program GL will expect to see a thorough and convincing disclosure of the rationale for any “one-off” awards, their linkage to performance, and their impact on “regular” compensation arrangements Compensation Committee Responsiveness to SOP Votes Compensation Committee responsiveness to prior SOP votes may also impact subsequent ISS and GL recommendations with regard to SOP, director re-elections, and equity plan proposals Designated threshold SOP support levels warranting enhanced demonstrations of shareholder engagement and Committee responsiveness are < 70% for ISS and < 75% for GL Many companies have already adopted clawback and stock hedging/pledging policies in response to shareholder and advisory group feedback and policies Proxy filings often include exhibits and narratives on the alignment of executive pay and performance Most are taking a “wait and see” approach with regard to CEO pay ratio provision, which is not currently expected to become effective until at least the 2017 proxy season. May be more a media relations than an investor relations issue
12 Shareholder Advisory Group Policies ISS Equity Plan Scorecard (EPSC)ISS EPSC provides a more holistic assessment of equity plan proposals, based on the following criteria: No weightings disclosed for sub-components; some count more than others (e.g., burn rate within grant practices pillar) Partial points can be earned for certain sub-components (e.g., SVT costs, burn rate) while others are pass / fail; to earn full points, SVT needs to be at 65% of ISS’s allowable cap (benchmark), and burn rate needs to be at or below 50% Minimum passing score = 53 points (out of max of 100); ISS expects outcomes to be similar to historical 30% failure rate Certain “egregious” practices (e.g., option repricing without shareholder approval, liberal CIC definition, problematic pay practices & pay for performance misalignment, tax gross-ups on equity awards) result in automatic “Against” recommendation Excessive SVT plan costs and burn rates can also result in automatic “Against” recommendations Implications of New Methodology More difficult to model / predict ISS voting recommendation, absent licensing ISS proprietary tool, which may place greater emphasis on shareholder outreach and proxy disclosure for companies with equity plan proposals Impact of failure to obtain shareholder approval for new / amended equity plan is more significant than non-binding SOP failure Most companies will only receive partial points under the sliding scale scoring system for SVT and burn rate, increasing the pressure to comply with some or all ISS grant practice / plan feature policy provisions For companies with equity plan proposals, this may result in further reductions in the prevalence of “single trigger” vesting provisions and “liberal” share recycling, and enhanced use of holding requirements
13 Enduring Principles Despite all the considerations and “noise” surrounding executive compensation, we have identified the following five enduring principles Aligning pay and performance—Ensuring that the compensation program encourages participants to grow the earning power and value of the company over time is essential to attracting and motivating the executive talent needed to propel the company forward. Balancing performance and retention—Effectively aligning pay and performance requires that companies also be able to retain and continue to develop executive talent through difficult periods—a point insufficiently recognized by many critics of executive pay. Avoiding unnecessary controversy that distracts from core principles—Practices that have low value, but provoke intense controversy (e.g., certain perquisites, tax gross-ups), should be eliminated to increase the focus on performance-based pay initiatives with the potential to provide real value to executives, the company, and shareholders. Transparency—Clear and effective disclosure of executive pay programs is more critical than ever. Like the underlying business strategies they are designed to support, compensation programs may be complex and unique. However, their purpose and structure should make sense to investors and plan participants through proactive internal and external communications. Good process—Compensation can be a highly emotional issue. Having open, candid and objective communication among Committee members, senior managers, and outside advisors is critically important to the Board’s working relationship with its CEO and other top executives.
14 2015 Proxy Season Preview Paul DeNicola Managing Director 2015 Proxy Season Preview Paul DeNicola Managing Director Center for Board Governance January 21, 2015
15 The governance landscape
16 Public company ownership composition
17 Shareholder voting rates
18 90% 30% The 2014 proxy season Percent of institutional shares votedShareholders continued to press public companies to adopt structural governance reform and the expectation is that smaller companies will begin to see more of this pressure Percent of institutional shares voted 90% Majority voting and declassified boards generally receive majority shareholder support Political spending disclosure, independent chair and climate change are the most prominent shareholder proposals Proxy advisory firms continued to exert significant influence Percent of retail shares voted 30%
19 The governance landscapeHighlights of 2014 proxy season1and 2013 recap 2014 2013 Issue # of proposals voted on # that passed Average support Political contributions and lobbying disclosure 81 3 24% 87 2 25% Independent board chair 62 4 31 61 6 32 Board declassification 15 14 84 30 79 Majority vote 27 16 57 17 59 Right to call special meeting 13 42 11 44 *Proxy access 12 5 37 *Under Rule 14a-8, shareholders can file proposals to require proxy access for director nominations. In 2012, the first year of this rule, 21 proposals were submitted, but only nine went to a vote as some were excluded or withdrawn. Source: Institutional Shareholder Services 2013 Proxy Season Review: US 1- As of June 26, 2014
20 The upcoming 2015 proxy seasonRise of the exclusive forum bylaw Requires common types of shareholder lawsuits be brought exclusively in Delaware's Chancery Court Proxy advisors’ voting policies: Glass Lewis generally votes “against” any bylaw or charter amendments adopting an exclusive forum unless the company gives a "compelling argument" as to why the bylaw benefits shareholders ISS has a vote case-by-case on exclusive venue proposals Fee shifting bylaw requires a party that brings suit against a company and fails to receive the remedy sought, the party could be obligated to reimburse the fees, costs, and expenses incurred by the corporation defending against such suit ISS and Glass Lewis generally recommend a vote “against” directors if the bylaws or charter are amended to diminish shareholders' rights
21 The upcoming 2015 proxy seasonProxy access proposals targeted at 75 companies Coordinated effort led by NY City Comptroller, Calpers, along with pension funds from Connecticut, Illinois and North Carolina The proposal will allow shareholders who have owned at least 3% of stock for at least three years to nominate directors to the board Average vote in favor of similar proposals receive approximately 50.1% over the period from
22 The governance landscape: Rise in shareholder activismThere are now more than $100 billion in assets under activist management1 Total number of actual proxy contests increased over the last two years1 The number of exempt solicitations (i.e., “no vote” campaigns against directors) nearly doubled1 In 2014, activists had a success rate of 72% in proxy fights, up from 60% last year1 It’s prudent for boards to discuss and prepare for a potential activist situation 1Hedge Fund Research, 2014.
23 The governance landscape: Rise in shareholder activismSource: PwC’s 2014 Annual Corporate Director Survey
24 Director communicationsDiverging views on director communications: 66% of directors say their board had direct communication with institutional investors, yet 22% believe “very much” it is not appropriate to engage directly with investors on any subject1 Director communications with stakeholders increased across all constituencies compared to prior year1 Shareholder Directors Exchange (SDX) Protocol issued and being promoted If the board does communicate: Decide which topics should be discussed and which director(s) will take the lead in discussions Ensure director is properly prepared to engage in the dialogue 1 PwC’s 2014 Annual Corporate Director Survey
25 10 questions directors should ask:What is the institutional and retail mix of our company’s share ownership? Do we fully understand the impact of retail voting at our company? How does our company’s size and mix of institutional and retail ownership impact the voting participation of our shareholders? Does the company have a communication program that allows for adequate engagement with all shareholders? How does our company’s shareholder support compare to that of our peers?
26 10 questions directors should ask: (cont.)Does the company anticipate a close shareholder vote on a sensitive issue? Are there situations where additional outreach to retail shareholders might make the difference on a close or sensitive voting issue? Do we understand the concerns of any shareholders who may decide to vote against one or more of our directors, and/or pay plan, and what have we done to engage them? Have we done sufficient cost/benefit analysis of our distribution method(s) for proxy materials and the effect on voting participation? Have we had sufficient discussions around potential changes to how the company distributes proxy material?