May 28 2015
At today’s Annual Meetings of public corporations across the United States, the media, investors, and stockholders have placed executive pay and compensation practices under their microscopes. As executive compensation and incentive plans continue to command attention, the SEC, IRS and the US Congress each have created new disclosure rules and regulations. It is imperative that HR professionals, compensation specialists, and corporate counsel be aware of the upcoming series of SEC and stock exchange listing requirements affecting how compensation committees approach pay practices.
This article is a very quick summary of a few recent laws and regulations impacting executive compensation. While most of these regulations were designed for, and only apply to, public companies, they have impacted private companies as many now comply with these regulations.
Sarbanes-Oxley, known as SOX since 2002, has provided the Securities and Exchange Commission (SEC) with the power to “claw back” executive pay and stock awards each year retroactively. The most powerful claw back provision in this Act is not only the change in standards, but has mandatory reporting requirements of ALL company perks, jets, country club memberships, etc. to the SEC.
The Dodd-Frank Consumer Protection Act has a “say on pay” provision, which requires all public companies to present to their shareholders an advisory resolution to approve compensation of its named executive officers, once every three years. These requirements have spawned a series of new SEC regulations affecting companies. The CEO pay ratio disclosure requirement has created great debates at recent stockholder meetings. In fact, according to FactSet SharkWatch, activist stockholders have launched 238 campaigns in just the first nine months of 2014 to force public corporations to make changes to their compensation plans. These campaigns have resulted in the rapid growth of compensation and proxy litigation this past year.
The most recent focus, resulting from the Dodd-Frank Consumer Protection Act, is the requirement that public corporations must have “performance-based” goals tied to executive compensation, and all “enhanced compensation” must be disclosed to the SEC. Together, these provisions will force HR leaders and compensation experts to focus on rewarding executives according to their actual performance. This shall cause Human Resources/People Operations Departments and compensation experts to return to performance–based pay, forcing them to re-write their compensation and incentive plans in accordance with the correct metrics for performance-based compensation.
As a result of the recent competition for talent, companies, both public and private, are adjusting to the newly imposed legal restrictions and are finding new, creative ways to structure compensation packages for attracting employees. Companies are now designing compensation and incentive programs that are heavily weighted toward long-term rewards and are performance-based.
Performance awards and incentive plan design are changing in today’s world. With the focus on aligning pay with performance, many companies now grant performance-vested long-term incentives (LTIs). For performance-vested LTI awards, HR leaders must determine the correct performance measures and effective goals/targets. This requires a balancing of the company, shareholder, market competitive landscape, as well as legal perspectives in designing corporate compensation incentive plans. Key considerations are the primary areas that drive shareholder value, as well as measures that capture overall business performance, including revenue and income.
With the increased focus on long-term performance driven by shareholders and the new governmental regulations, publicly traded companies have been increasingly adopting Performance Shares or Units. These are shares, or share units, representing actual shares of a company’s stock with the vesting no longer dependent on a number of years of service, but with vesting dependent on the achievement of pre-established performance objectives and set targets.
Companies are also moving away from stock options and towards cash performance awards with payout dependent on pre-established performance goals. In addition, there has been a growth in the use of performance-vested Restricted Stock Units (RSUs), utilizing objectives for vesting rather than years of service to achieve the award. Finally, even stock options and stock Appreciation Rights (SARs), rights to purchase company stock at a pre-set exercise price, are becoming dependent upon the achievement of performance objectives before they become vested. Clearly, the time is now to move away from time–vested awards, which do not motivate better performance, and create accurate performance-based incentives.
The issue for human resources and compensation professionals becomes which performance metrics should be utilized when crafting their incentive compensation plans? And, more generally, pay for what performance? Corporations currently issuing performance award payouts have utilized several measurements. Specific performance measures include revenue growth, net income growth, EBITDA growth, EPS growth, return on capital, return on equity, and total shareholder return.
In summary, due to the changes in our economy and new governmental regulations, for the first time in executive compensation history, more than half of companies are granting performance-based awards as part of their incentives program. While the use of such awards is becoming more common, their effectiveness in aligning pay with actual company and individual employee performance is the challenge presented to us.
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