Draft Pay Ratio Rule Spurs Debate
A divided U.S. Securities and Exchange Commission voted Sept. 18 to approve a controversial draft rule mandating company disclosure of the median of the annual total compensation of its global workforce, excluding the CEO, alongside a ratio of that median to the annual total compensation of its CEO.
The proposed rule, mandated under Section 953(b) of the Dodd-Frank Act of 2010, was narrowly approved in a 3-2 vote with SEC Chair Mary Jo White siding with Democratic Commissioners Luis Aguilar and Kara Stein in seeking public comment on the proposal. Despite the commission’s decision to give companies flexibility in determining the calculus for median employee pay, the draft rule has reignited debate over cost-benefit analyses of laws forged in the wake of the financial crisis.
Key provisions of the draft rule would allow companies to determine the methodology used to calculate median employee pay “appropriate to the size and structure of their own businesses and the way they compensate employees.” Most notably, a company would be permitted to identify the median employee based on total compensation using either its full employee population or a statistical sample of that population, an option long promoted by champions of the rule seeking to counter critics’ claims of difficulties inherent in collecting information for the entire workforce.
According to the SEC, companies could identify the median of its population or sample using annual total compensation as determined under existing executive compensation rules or by using any consistently used compensation measure such as compensation amounts reported in its payroll or tax records. A company would then calculate the annual total compensation for that median employee in accordance with the definition of total compensation set forth in the SEC’s executive compensation rules.
A controversial provision within the draft rules concerns the geographic scope of employees covered under the regulation. Critics of the rule questioned the value of including median pay for employees outside the U.S. without adjusting for cost-of-living and other differences, and where the complexity of collecting such information could prove burdensome for U.S. corporations. SEC officials, however, note that Dodd-Frank specifies “all employees,” resulting in the draft rule applying to: all employees (including full-time, part-time, temporary, seasonal and non-U.S. employees; those employed by the company or any of its subsidiaries; and those employed as of the last day of the company’s prior fiscal year.
Companies would be permitted but not required to annualize the total compensation for a permanent employee who did not work for the entire year, such as new hires, according to an agency summary of the proposal. Critically, full-time equivalent adjustments for part-time workers, annualizing adjustments for temporary and seasonal workers, or cost-of-living adjustments for non-U.S. workers would not be permitted.
While companies would be free to develop the methodology used to determine median employee pay, the rule requires disclosure of the methodology, as well as “any material assumptions, adjustments or estimates used to identify the median or to determine total compensation.” If a company identifies a median employee based on a consistently applied compensation measure, the proposed rule would require disclosure of the measure that it used, the SEC said. Also, companies would be required to clearly identify any amounts that are estimated.
Periodic disclosure of the information would be done through registration statements, proxy and information statements, and annual reports that “must already include executive compensation information as set forth under Item 402 of Regulation S-K,” according to the agency.
Companies would need to begin disclosing the information in their annual report on Form 10-K for the fiscal year following approval of the final rule, meaning 2016, were the rule approved in 2014.
The business community, vocal in its opposition to many recently promulgated SEC rules stemming from Dodd-Frank, is voicing deep concern over both the costs and benefits of pay ratio disclosures, arguing investors will find the information immaterial and multi-national firms will face significant administrative challenges and expenses in collecting the information.
Setting the tone for opposition to the draft regulations, Republican Commissioners Daniel Gallagher and Michael Piwowar decried the proposal as distracting to investors “at best” and misleading at worst, with no other purpose than to “shame U.S. companies.”
Criticizing the global scope of the proposed rule, Gallagher said requiring issuers to calculate the median salary based solely on their own full-time employees located in the U.S. would “still have yielded pay ratio figures more than impressive enough to serve the law’s scapegoating and shaming goals.” Such a calculation would still have been complex, he noted, “although much less costly and more in line with our responsibility as regulators to strike an appropriate balance between costs and benefits.”
“Of what conceivable use could comparing the pay of workers in developing nations to that of U.S. CEOs be to the investors the SEC is tasked with protecting,” Gallagher asked at an open meeting to approve the draft regulations for public comment. “Why include part-time and temporary and seasonal employees? Why incorporate currency exchange assumptions or pay variations due to governmental social benefits schemes that vary from country to country? These and other extraneous variables introduce a degree of complexity and obfuscation that renders meaningless what was meant to be a simple ratio.”
Business lobbies, including the U.S. Chamber of Commerce, similarly lambasted the proposal, questioning its utility and suggesting politics, rather than investor interests, were at the heart of the Dodd-Frank mandate. “This proposed rule is another example of special interests promoting policies contrary to the interests of investors and the businesses they invest in,” said David Hirschmann, head of the Chamber’s Center for Capital Markets Competitiveness. “Pay ratios will not give any insight on the performance of a company or its management and fail to give investors decision-useful information or assist with capital formation. This proposal has the potential to drive up compliance burdens and costs for public companies with no benefit to investors.”
Concluding his remarks, Gallagher emphatically called on financial market participants to provide “detailed, data heavy comments” during the public comment, suggesting opponents may again seek to derail a Dodd-Frank mandate via the judiciary. The Chamber of Commerce, notably, was party to successful suits vacating rules on proxy access and disclosure of payments by extractive companies to foreign companies in July of 2011 and 2013, respectively.
Gauging Investor Support
With the SEC acknowledging in the draft release that it’s faced “significant challenges in quantifying potential economic benefits, if any, from the pay ratio disclosure,” investor comment on the potential benefits is critical, proponents of the rule say.
Advocates contend the disclosures will help investors evaluate CEO pay levels in a broader context and could mitigate the trend of benchmarking CEO pay with that of other CEOs, which, they argue, has resulted in a ratcheting effect.
“The simple fact is that large pay disparities between CEOs and their employees affect a company’s performance. When the CEO receives the lion’s share of compensation, employee productivity, morale and loyalty suffer,” said AFL-CIO President Richard Trumka in a statement released on the heels of the Sept. 18 commission meeting. “In contrast, reasonable CEO-to-worker pay ratios send a positive message to the workforce that the contributions of all employees are important to running a successful company.”
Echoing Trumka, CalPERS CEO Anne Stausboll similarly welcomed the rule, saying the California pension fund, the U.S.’s largest, “believes that long-term value creation requires the effective management of human capital,” and that the proposal “further opens the window on CEO pay and will help shareholders to keep management accountable.
“Companies should welcome the new opportunity to articulate their approach to value creation through the transparency of their compensation practices across their workforce,” she noted. “That is good for business and good for shareholders."
One potential measure of whether shareholders see this as a benefit is through support for the handful of pay disparity shareholder resolutions voted on in recent years. An ISS analysis of voting on such resolutions dating back to Jan. 1, 2009, finds average support of votes cast at just 8 percent across 16 companies, with a high of 17.4 percent at First Commonwealth Financial in 2011, followed by 11.6 percent at ExxonMobil in 2009.
The proposal to Exxon, filed by NorthStar Asset Management, called for the company to prepare a report comparing the total compensation of its CEO with the increase in the average U.S. per capita income between 1998 and 2008. It also asked that the report include an analysis of changes in the relative size of the gap between the two groups and the rationale “justifying this trend.” Like CalPERS’ argument regarding pay ratio disclosures and human capital management, NorthStar contended evaluation of the gap would prompt the company to consider investing in more of its employees, rather than just one.
SEC officials are calling on market participants to provide for thoughtful and detailed commentary during the consultation period, which runs for 60 days from the date of publication of rules in the Federal Register. In particular, they seek feedback on the benefits to investors, as well as the cost to issuers of collecting the information, which agency staff have been unable to determine due to the proprietary nature of the information.
The commission will post comments to its site as they come in.--Subodh Mishra, Governance Exchange
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Europe, Africa, & Middle East
NAPF Report Highlights Unresponsive Companies
A Sept. 16 report by the National Association of Pension Funds identifies U.K. companies that bucked a 2013 trend for “quiet diplomacy” by failing to respond effectively to shareholder concerns about remuneration.
The NAPF analysis shows that while most companies who faced significant rebellions by their shareholders in the “shareholder spring” of 2012 “have listened and learned,” there are a few who have not. Afren, Immarsat, and Babcock are among 10 FTSE companies highlighted which, having received a warning from shareholders last year, received more than 15 percent dissent (votes against and abstentions) on their remuneration report in 2013, the NAPF said in a statement. The report details where the three companies fell short of investor expectations, as well as those which saw significant increases in support this year, such as Aviva, Tullow Oil, and Quintain Estates.
Most companies acted to avoid the reputational damage inflicted by 2012’s high profile shareholder rebellions by engaging more and earlier with shareholders, says the NAPF, and also appear to be cautious about introducing change ahead of the remuneration disclosure regulations and the binding vote on remuneration policy which take effect next month.
“We hope that highlighting the few companies where shareholders have felt compelled to give the company another reprimand will cause them to reflect, listen to shareholder concerns and introduce changes next year,” said NAPF head Joanne Segars in a statement. “We will continue to keep an eye on them and encourage all companies to assess whether their current remuneration practices align rewards to long-term success and returns to shareholders.”
This year’s inaugural report also explores shareholder voting on auditors, which has been in focus following corporate governance code changes last year recommending regular tendering and rotation of auditors, and sweeping reforms to the U.K.’s statutory auditor market expected soon from the Competition Commission (for more on those proposals, please see the July 26, 2013, edition of Governance Weekly).
The NAPF lists four “significant rebellions” against audit-related resolutions this year where shareholders signaled their dissatisfaction over high levels of non-audit fees, including at Pennon Group, Inmarsat, Unite Group, and Laird. Meanwhile, other companies headed off audit-related disputes by either tendering their longstanding auditor contracts or “indicating an intention to do so in the near future,” the report states. These included: HSBC, which moved the U.K.’s largest audit contract after a more than 20 year relationship with KPMG, according to the NAPF; Unilever, which ended a 26 year relationship with PwC; Land Securities, where PwC was replaced by Ernst & Young after 69 year tenure; and BG Group, where PwC replaced Ernst & Young, which had been in place since the company’s incorporation in 2000.--Subodh Mishra, Governance Exchange
Directors Group Warns on Governance Proposals
The London-based Institute of Directors responded this week to a government discussion paper on potential reforms to rules governing smaller companies and their directors, arguing some of the proposals may staunch enterprise and excessively penalize directors at failed companies.
At issue for the IoD are provisions for consideration within the Transparency & Trust: Enhancing the Transparency of UK Company Ownership and Increasing Trust in UK Business consultation, which closed earlier this week. The discussion paper outlines a range of proposals to “enhance the transparency” of U.K. company ownership and “increase trust” in U.K. business by hindering such activities as money laundering and tax evasion, while also giving investors and others “tools” to hold companies, and their boards, to account.
While welcoming a key proposal to create a central, public registry of beneficial owners of U.K. companies, the IoD says it is concerned with several others that may place an “excessive burden” on smaller companies and their directors. Specifically, it questions a proposal that after a certain number of company failures, a director should be presumed to be unfit to practice and should be automatically disqualified. The IoD says it views company failure as an inevitable aspect of a market economy, and director should not be penalized (in the absence of proven wrong-doing). Moreover, the group also takes issue with another proposal giving liquidators the right to sell or assign financial claims against the directors of failed companies to debt collectors or other agents unconnected with the company. Such a punitive approach “will do little to encourage experienced business people to offer their time and experience to the boards of small and medium-sized companies,” it argues.
“We agree with the government that good corporate governance is inherently linked to trust and confidence in our capitalist system, and that this trust has been severely tested by the economic problems of the last five years,” said Roger Barker, director of corporate governance at the IoD, in a Sept. 16 statement. “However, some of the proposals in the discussion paper are suggestive of anti-enterprise attitudes towards business failure. They also take an excessively punitive approach towards the directors of failed companies.”--Subodh Mishra, Governance Exchange
PwC: U.K. Executive Bonuses Decline for Second Year in a Row
U.K. executives have seen their bonuses fall for the second year in a row, and one in 10 received no bonus at all in 2013, finds a recent PwC study of 204 FTSE350 companies.
The findings suggest both restraint and widespread responsiveness following the “shareholder spring” of 2012. Total pay (made up of salary, bonus, long-term incentives and pension) has been largely static across FTSE 350 senior management positions, according to a summary of the findings. Where salary increases have been given, they have been roughly in line with inflation at an average of 3 percent, which is consistent with 2012 levels, says PwC. The analysis reveals that around one in five of FTSE100 and 15 percent of FTSE250 chief executives have seen pay freezes in 2013.
Where bonuses were awarded to FTSE 100 chief executives, the average (median) payout was £905,000, representing a 7 percent fall from 2012 when the median was £975,000. This means FTSE100 chief executives received on average just over two thirds of maximum payout, according to the report, which is a drop from the high in 2011, where bonus payouts were typically over three quarters of the maximum.
PwC says its data indicates that FTSE350 companies are planning minimal changes to pay levels next year, with most budgeting pay rises of between 2.5 percent and 3.5 percent for all management levels.--Subodh Mishra, Governance Exchange
CalPERS Adopts ‘Investment Beliefs’ to Guide Portfolio Management
Fund giant CalPERS adopted Sept. 16 a set of 10 “Investment Beliefs” that will underpin strategic management of its investment portfolio, inform organizational priorities, and ensure alignment between the investment office and CalPERS staff.
Each investment belief also includes more detailed sub-beliefs that are actionable statements providing insight as to how overarching principles will be implemented.
“The adoption of CalPERS Investment Beliefs marks another step in the System's work to integrate its assets and liabilities, and ensure CalPERS is sustainable over multiple generations,” fund ofcials said in a Sept. 16 statement.
Development of the principles began in 2012 with participation from the CalPERS Board of Administration, CalPERS staff and investment consultants, according to the fund. The process started with detailed interviews with board members and staff to identify themes and gather data. A series of public workshops were then conducted throughout 2013 to work through unsettled issues, as well as to include input from stakeholders and members of the public.
CalPERS’ Investment Committee also conducted a first reading of the policy that will provide context for how the guidance should be used. The policy makes clear that the principles are a “framework” for making decisions and “not a checklist to be applied to each decision.” It also requires periodic review of the Investment Beliefs. A final version of the policy will be adopted at the October Investment Committee meeting.--Subodh Mishra, Governance Exchange
CalSTRS Touts 2013 Success on Majority Voting
The California State Teachers' Retirement System (CalSTRS) announced Sept. 18 that 77 of 82 companies it engaged with in 2013 adopted a majority vote standard in corporate board elections.
Of the full tally, 42 adopted a majority vote standard upon withdrawal of a shareholder proposal requesting the change, while another 24 did so without having a proposal filed. Eleven resolutions went to a vote and passed, according to Sacramento-based CalSTRS, while five resolutions failed.
The majority voting standard requires that a sitting board member receive a majority of the shareholder votes cast in order to remain on the board. This contrasts with the plurality vote standard, which allows a board nominee to be elected with a single affirmative vote.
"Our 93 percent success rate this year is particularly satisfying, because we changed our focus from large to small cap companies," said CalSTRS Director of Corporate Governance, Anne Sheehan. "Moving 77 companies from a strict plurality standard is a huge step in the right direction."
According to data drawn from ISS’ Governance QuickScore, more than three-quarters of all S&P500 firms have a majority vote standard alongside a director resignation policy, with another 7.4 percent maintaining that standard but without a director resignation policy. Of 380 large capital firms profiled in 2013, just 80 use a plurality vote standard. By contrast, across the full Russell 3000, less than 27 percent of firms use a majority vote standard, with the vast majority still employing a plurality vote in director elections.--Subodh Mishra, Governance Exchange
JPM Admits Governance Lapses in Settling ‘London Whale’ Charges
The U.S. Securities and Exchange Commission disclosed Sept. 19 a settlement with JPMorgan Chase over its misstating of financial results and lack of “effective internal controls” that led to massive trading losses in 2012 by a U.K.-based trader dubbed the “London Whale.”
The Wall Street firm agreed to settle SEC charges by paying a $200 million penalty, “admitting the facts underlying the SEC’s charges, and publicly acknowledging that it violated the federal securities laws,” the SEC said in a statement. Some SEC watchers have criticized the agency’s practice of settling with firms, which often pay fines without admitting to wrongdoing
According to the SEC, in late April 2012, after the portfolio in question began to significantly decline in value, JPMorgan commissioned several internal reviews to assess, among other matters, the effectiveness of the chief investment office’s (CIO) internal controls. From these reviews, senior management learned that the valuation control group within the CIO--whose function was to detect and prevent trader mismarking--was “woefully ineffective and insufficiently independent” from the traders it was supposed to police. As JPMorgan senior management learned additional troubling facts about the state of affairs in the CIO, they failed to timely escalate and share that information with the firm’s audit committee.
Among the facts that JPMorgan has admitted in settling the SEC’s enforcement action:
As a result of the findings of certain internal reviews of the CIO, some executives expressed reservations about signing sub-certifications supporting the CEO and CFO certifications required under the Sarbanes-Oxley Act.
Senior management failed to adequately update the audit committee on these and other important facts concerning the CIO before the firm filed its first quarter report for 2012.
Deprived of access to these facts, the audit committee was hindered in its ability to discharge its obligations to oversee management on behalf of shareholders and to ensure the accuracy of the firm’s financial statements.
As part of a coordinated global settlement, three other agencies also announced settlements with JPMorgan Sept. 19, including the U.K. Financial Conduct Authority, the Federal Reserve, and the Office of the Comptroller of the Currency. JPMorgan will pay a total of approximately $920 million in penalties in these actions by the SEC and the other agencies.--Subodh Mishra, Governance Exchange
Towers Watson: U.S. Director Pay Sees Modest Gain in 2012
Fueled by a jump in cash compensation, total pay for outside directors at the nation’s largest corporations increased modestly in 2012, according to a Towers Watson analysis released Sept. 17. The findings show that companies increased the value of annual retainers and continued to shift away from variable forms of pay, which helped to increase the cash element of directors’ total compensation package, the consultancy noted in a statement.
The analysis which covered compensation for outside directors at 469 publicly owned Fortune 500 companies, found that total direct compensation for directors increased by 3 percent at the median last year, from $220,000 in 2011 to $227,000. That is slightly lower than the 5 percent increase in director total compensation in 2011, according to Towers. Total compensation includes cash pay, and annual or recurring stock awards.
Meanwhile, the median value of cash compensation jumped 8 percent last year, to $100,000, “driven primarily by the first increase in the median cash retainer in two years,” according to Towers. Compensation from annual and recurring stock awards remained virtually unchanged last year at $125,000, the analysis found.
Notably, continuing the trend of the past several years, companies replaced various types of variable cash pay for directors, such as per-meeting fees for board and committee service, with new or increased retainers, according to the analysis. The prevalence of per-meeting fees for board meetings dropped from 32 percent to 28 percent over the past year, while the practice of providing meeting fees for committee meetings fell from 37 percent to just over a third. By comparison, the prevalence of flat cash retainers for committee service increased slightly, while the median committee member cash retainer rose from $7,500 to $8,000.
Other key findings include:
While the median annual equity award value did not increase in 2012, equity remains a significant portion of the pay program for directors of most companies. The average pay mix for Fortune 500 directors remains 45 percent cash and 55 percent equity.
Stock ownership guidelines and stock retention policies for director pay programs have been adopted by most companies. In 2012, 89 percent of companies had either or both types of mandates, up from 87 percent in 2011. The median value of stock ownership required for directors subject to stock ownership guidelines increased from $300,000 in 2011 to $350,000 in 2012.
Since the Delaware Chancery Court’s ruling last year in Seinfeld v. Slager, a growing number of companies have adopted limits on the size of grants that can be awarded to directors under new or amended equity plans. Over a fifth (22 percent) of the Fortune 500 companies that adopted or amended stock plans in the past year added a director-specific annual grant limit.
Download the report here.--Subodh Mishra, Governance Exchange
Majority Vote at Darden Marks Fifth for Proxy Access
A proxy access proposal voted Sept. 18 at Darden Restaurant’s annual meeting brings to five the count of majority supported resolutions in 2013 seeking to allow shareholders to nominate corporate directors.
The proposal, filed by the Nathan Cummings Foundation, follows majority support for such resolutions at Verizon Communications, CenturyLink, Nabors Industries, and Advanced Phoenix, a micro-cap company. All of the resolutions--save for that filed to Advanced Phoenix--were non-binding and call for the right for 3 percent holders for three years to nominate up to no more than one-quarter of the board.
Four other shareholder proposals at yesterday’s meeting--including one calling for a majority vote standard in director election--failed to receive majority backing from shareholders, according to press reports, though the access resolution showing was not a surprise to some.
“Given the growing consensus among shareholders that proxy access is part of any best practice governance regime and the company's recent tendency to be relatively slow to respond to shareholder concerns, we were expecting a strong vote,” Laura Campos, director of shareholder activities at the Nathan Cummings Foundation, told Governance Weekly. “A majority of Darden shares were clearly voted in favor of the proposal, what remains to be seen is just how large a percentage opposed the Board's recommendation on this issue.”
The company said it would release vote results by Tuesday in filings with the SEC, while a company official told the Orlando Sentinel they did “not know when directors will decide whether to implement the proposal.”--Subodh Mishra, Governance Exchange
Investors to Sharpen Focus on Board Diversity
Shareholder advocates of greater board diversity will accelerate their push for a greater number of female directors going into 2014, according to Tim Smith, co-chair of the Thirty Percent Coalition’s Institutional Investor Committee (IIC).
To date, the coalition has been active in calling on nomination committees at firms with male-only boards to consider appointing female directors, with 168 Russell 1000 companies receiving letters urging them to “consider gender diversity in the boardroom as a priority.” The letters, signed by institutional investors representing over $1.2 trillion in assets under management, cite studies “demonstrating a correlation” between greater gender diversity among corporate boards and management, good corporate governance, and long-term financial performance, according to the IIC.
In one sign of progress, IIC officials recently noted the appointment of female directors at eight companies, including QEP Resources, Noble Energy, Quanta Services, Riverbed Technology, Crane Co., LPL Financial Holdings, American Financial Group, and NetApp.
“We do consider the positive responses of a number of companies an important step in the right direction,” said Smith. Still, he acknowledged, progress has been “painfully slow” with more to be done as investors send follow-up letters to unresponsive companies and continue their dialogue with dozens of portfolio firms with whom agreement has yet to be reached.
In comments to Governance Weekly, Smith predicted more activity over the coming months in the lead up to the 2014 proxy season with a greater number of shareholder proposal filings from a “more active and energized” group of investors.
“There’s a lot in the way of momentum,” said Smith, citing a legislative proposal pushing board diversity at California firms, green shoots from quotas (which are not advocated by the 30 Percent Coalition) in Europe, and new investor members joining the coalition.
During the 2013 proxy season, shareholder resolutions on board diversity were filed with 25 companies, according to the IIC. Of the 25 shareholder resolutions filed, 18 have been withdrawn based upon mutual agreements, an important mark of progress in the work on board diversity. Three resolutions went to a vote at CF Industries, Urban Outfitters, and Freeport-McMoRan Copper & Gold, receiving support of 50.7 percent, 27.5 percent and 28.9 percent of votes cast, respectively. The vote at CF Industries marks the first time a board diversity resolution has received majority support from shareholders.--Subodh Mishra, Governance Exchange
Study Links Social Responsibility Disclosure and Profits
Corporations that make social responsibility disclosures beyond the norm have a tendency to be more profitable over the long-term than those that don’t, according to a new academic study.
The study, Are CSR Disclosures Value Relevant? Cross-Country Evidence, differs in three ways from those done previously. First, it uses samples from 21 countries, while most others concentrated on one, according to the authors. Second, the new study focuses on companies that made corporate social responsibility (CSR) disclosures that exceeded expectations based on legal requirements, firm characteristics, etc., instead of those that just met them (or failed to meet them). Finally, it relies on a rating by global auditing company KPMG of the top 100 firms in these countries rather than a self-constructed disclosure index.
“Our findings suggest that firms with higher abnormal (unexpected) CSR disclosure have higher firm value across various categories of industries and firm types, suggesting that CSR concerns are persuasive and that CSR disclosures play a significant role in firm valuation,” the report reads.
“A unit increase in abnormal CSR disclosure sends a stronger signal to market participants in these countries,” says study co-author Debra Jeter of Vanderbilt University’s Owen Graduate School of Management. “An alternative, though not unrelated, explanation is that superior CSR disclosure in countries with weaker governance may serve as a signal that the firm is more forthcoming in general. Thus, the market might view the voluntary CSR disclosures as indicative of financial reporting that aligns more closely with the firms’ underlying economic reality.”--Subodh Mishra, Governance Exchange