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2020 was a challenging year for banks. The impact of COVID on the economy as well as changes to accounting for loan loss provisions were evident in weaker financial and stock price performance in 2020 for many banks and yet CEO compensation increased. Learn from experienced executive compensation consultants about the challenges Compensation Committees faced in 2020, why pay levels increased relative to 2019, what were common COVID-related compensation changes, and what changes were made for the 2021 incentive plan design. Also, hear about if and how banks are linking executive compensation to diversity and inclusion metrics given the increased focus on ESG. The compensation consultants will share findings from their 2020 compensation study, lessons learned from 2020, and best practices for 2021 and beyond.

Say on Pay arrived in 2011, born out of the SEC’s rule-making efforts to reform corporate governance under Dodd-Frank after the financial crisis. This non-binding advisory vote, which is an annual event at most companies, allows shareholders to cast votes for or against Named Executive Officer (NEO) compensation. While earning simple majority support is technically a passing result, most companies strive for and achieve significantly higher levels of support. Investor support of compensation programs is influenced by many factors, which primarily include magnitude of pay, pay practices, and stock price performance.

In 2020, COVID-19 significantly disrupted the global economy, causing many companies to re-evaluate their compensation programs. Proxy statements filed in 2021, which will discuss compensation during the COVID pandemic year, will depart from previous norms. In anticipation of these filings, CAP has reviewed Say on Pay voting results at Russell 3000 companies in 2020, and since inception, to gauge the current landscape with an eye on what may occur with 2021 Say on Pay results.

Say on Pay Overview

Russell 3000 Historic Results

2020 marked the 10th year of Say on Pay voting. To date, voting results have generally been very consistent over time. Median support among Russell 3000 companies has been approximately 95% in each of the past 10 years. Most companies receive support from over 90% of shareholders, with an average of 74% of companies receiving support in the 90-100% range. Consistent vote outcomes are seen at the top and the bottom end of the range. The percentage of companies falling in each range shown below has been consistent throughout the 10-year history of Say on Pay voting.

All Companies

2020

2011 – 2020

Average

Range

Median Level of Support

94.9%

95.2%

94.7% – 95.6%

>90% Support

74.0%

73.8%

70.0% – 76.8%

2%2%3%1%2%2%2%2%2%2%2%2%2%2%2%2%2%2%3%2%3%4%4%4%4%3%4%4%3%4%5%6%5%5%6%6%6%7%7%8%14%12%11%11%13%12%13%13%13%15%74%74%75%77%74%76%74%73%72%70%0%10%20%30%40%50%60%70%80%90%100%20202019201820172016201520142013201220110% - 50%50% - 60%60% - 70%70% - 80%80% - 90%90% - 100%Level of Support - All Companies

Only 2.2% of companies failed to receive majority support for Say on Pay votes in 2020. The number of companies that have failed the Say on Pay vote has also been very consistent over the 10-year period, with an average of 2.0% of companies failing over the past 10 years. For companies that failed in 2020, the median level of support was approximately 38%, mirroring historical results.

All Companies – Failed Say on Pay Vote

2020

2011 – 2020

Average

Range

% of Companies Failing

2.2%

2.0%

1.4% – 2.4%

Median Level of Support

38.2%

39.2%

33.1% – 42.7%

Proxy Advisor Impact

Proxy advisors have a substantial impact on the Say on Pay vote for companies. The most influential proxy advisory firm is Institutional Shareholder Services (“ISS”) which grades companies on a pay-for-performance scale to determine if, in their view, CEO pay and company performance are well-aligned. ISS will then issue a recommendation “For” or “Against” the NEO compensation program, ISS’ vote recommendation often has a substantial impact on the vote result, as outlined below.

The two main inputs that ISS looks at are CEO compensation and Total Shareholder Return compared to an ISS-defined peer group based on company size and industry. Companies will then receive a “Low”, “Medium” or “High” concern level that determines whether ISS performs a qualitative evaluation of the compensation program. The overall concern level drives ISS’ ultimate recommendation For or Against the Say on Pay resolution. Historically, approximately 95% of companies with a Low concern receive support from ISS, compared to about two-thirds of companies rated Medium concern and roughly half of the High concern companies. Often, shareholders will reference the ISS recommendation (i.e., For or Against) when casting their vote on Say on Pay; however, many institutional investors have their own proprietary tests to evaluate compensation programs at companies.

ISS has consistently recommended Against Say on Pay for approximately 12% of companies per year, over the last decade. Among companies that have failed Say on Pay, the vast majority, 96% on average, have received an Against recommendation from ISS. In 2020, roughly 20% of companies that received an ISS Against recommendation ultimately failed the vote and for all companies with an Against recommendation from ISS, the median level of support was only 67%.

ISS Against Recommendation Impact

2020

2011 – 2020

Average

Range

% of Companies with ISS Against Recommendation

10.4%

11.6%

10.0% – 13.5%

% of Companies with ISS Against Recommendation Failing Say on Pay

19.5%

16.3%

10.6% – 21.5%

Median Level of Support

67.0%

67.4%

65.1% – 70.4%

As shown below, the percentage of companies with an ISS Against recommendation, at each support level range, has been generally consistent since the Say on Pay vote was established.

20%19%18%11%14%23%17%17%18%13%15%16%17%12%19%15%15%18%23%16%25%26%26%26%24%23%22%22%16%21%21%24%23%24%20%20%21%22%23%23%12%10%10%17%16%14%16%13%11%17%8%6%7%10%7%5%10%8%8%10%0%10%20%30%40%50%60%70%80%90%100%20202019201820172016201520142013201220110% - 50%50% - 60%60% - 70%70% - 80%80% - 90%90% - 100%Level of Support - Companies Receiving an ISS Against Recommendation

Expectations for 2021

Institutional Shareholder and Proxy Advisor Commentary

2021 proxy statement disclosures will reflect the impact of COVID-19 on company performance which influenced both executive compensation in 2020 and the development of 2021 incentive programs. While the degree of impact will vary by industry and company, many more companies than usual will disclose adjustments to their compensation programs than in past years. During 2020, shareholders and proxy advisors provided some general guidance on how they will be assessing and evaluating these unique circumstances.

Institutional shareholders and proxy advisors have both stated that they recognize that 2020 was a more challenging year than most due to the impact of COVID-19. Because of this, they will review companies on a case-by-case basis, evaluating the facts and circumstances that went into any adjustments that were made. Guidance has generally encouraged proactive, enhanced disclosure that clearly explains the situation and rationale for COVID-related changes as opposed to generic descriptions of a challenging year, which may be viewed as insufficient.

How shareholders and proxy advisors interpret and assess the COVID-related disclosures and adjustments will ultimately influence Say on Pay votes and recommendations. While ISS and Glass Lewis did not make wholesale changes to their pay-for-performance evaluations for 2021, ISS did call out key disclosure items that would help investors evaluate COVID-related changes. This indicates that there may be more discretion and flexibility applied for companies with more robust disclosure. Even with greater flexibility in the qualitative evaluations, pay-for-performance misalignment will continue to be the main driver for Against recommendations from ISS in the broader market.

CAP Expectations

Since pay-for-performance is expected to remain the primary driver for proxy advisor recommendations, Say on Pay results will continue to depend on the magnitude of pay, pay practices and stock price performance. For companies that may have a pay and performance misalignment, we expect reduced shareholder support if a company has not provided sufficient rationale for the following actions:

  • Annual and long-term incentive plan adjustments
  • Major employee actions (e.g., layoffs)
  • Performance that is dramatically below investor expectations
  • Low relative financial performance
  • Above-target discretionary adjustments to payouts that previously missed threshold performance
  • Awarding one-time special cash/equity grants

Shareholder outreach will be more important in 2021 as companies can use these discussions to supplement their required disclosures. Proactive outreach may help to prevent a significant impact on the Say on Pay result even if proxy advisors recommend Against a company’s compensation program. There will also likely be more disclosure on go-forward incentive programs, as the impact of COVID-19 lingers into 2021.

Say on Pay results in 2021 will likely depart from prior norms. Even if the percentages of Against recommendations and companies passing remains relatively consistent with historic levels, we expect to see a downward shift in the median level of support and in the percentage of companies receiving at least 90% support. For companies that do receive an Against recommendation from proxy advisors, the level of support may decline compared to historic norms if disclosures do not sufficiently justify the actions taken.

Conclusion

2021 Say on Pay results will likely test the “steady state” seen over the previous 10 years. While the full picture will not be clear until later this year, CAP has begun to look at companies with fiscal years ended in late 2020 to get an early read. We will continue to monitor Say on Pay results throughout the year to see how the COVID-19 pandemic shapes these results.

On November 13, 2019, Institutional Shareholder Services (ISS) made two key changes to its Quantitative Pay-for-Performance Screens for 2020.

    1. ISS changed the Financial Performance Assessment (FPA) to be based on Economic Value Added (EVA) metrics (EVA Margin, EVA Spread, EVA Momentum vs. Sales, EVA Momentum vs. Capital) instead of the GAAP metrics that were used in 2019. The FPA will continue to be used as a secondary modifier screen affecting a relatively small number of companies.

      ISS will continue to include the GAAP metrics in the report. Though they will not be used in the quantitative assessment, they may be included in the overall ISS evaluation of pay and performance alignment.

      We expect that many companies will engage with ISS to determine their performance on the EVA metrics, given the complexity in replicating the EVA metrics from GAAP financial information.

 

  1. ISS made changes to the thresholds that will trigger concern for the Relative Degree of Alignment (RDA) and the Pay-TSR Alignment (PTA) tests.

 

Measure Policy Year Eligible for FPA Adjustment Medium Concern High Concern
Relative Degree of Alignment 2019 -28 -40 -50
Relative Degree of Alignment 2020 -38 -50 -60
Pay-TSR Alignment 2019 -13% -20% -35%
Pay-TSR Alignment 2020 -22% -30% -45%

These changes will be welcomed by issuers as they lower the likelihood of ISS undertaking a qualitative review of a company’s pay program that may trigger an against recommendation from ISS on the Say-on-Pay vote.

CAP partners Bertha Masuda and Susan Schroeder discuss essential components to building robust long term and short term incentive plans as well as what companies overlook when developing incentive plans for their employees

Stock price growth? Meeting the business plan? Beating external expectations? Long-term stability? Companies must consider success across multiple fronts, and boards of directors play a role in defining success by working with management to set the strategic plan and by overseeing how the company progresses toward the achievement of the plan.

Incentive plans are foundational to motivating the senior management team to achieve the goals of a company’s strategic plan. Determining how to best measure and reward performance against these goals is key to designing effective incentive compensation programs that ensure proper alignment of pay outcomes with various degrees of suc- cess against the plan.

To determine how board members measure performance and incorporate it in their company’s incentive compensation plans, Corporate Board Member and Compensation Advisory Partners partnered to survey more than 250 public company directors. In this report, we present our findings and share our perspective on these key issues.

Download the PDF to read the full report.

Beginning with fiscal years ending on or after December 31, 2017, companies are required to disclose the ratio that compares the compensation of the CEO to the compensation of the median employee (pay ratio). This disclosure was part of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law in 2010.

Compensation Advisory Partners LLC (CAP) researched early pay ratio disclosures. As of March 9, 2018, we obtained pay ratios from 150 companies with a median revenue of $2.1B from a cross-section of industries.

Pay Ratio

The median pay ratio disclosed by these companies is 87x. The lowest ratio is 1x (Apollo Global Management, Dorchester Minerals and The Carlyle Group) and the highest ratio is 1465x (Fresh Del Monte Produce Inc.).

Summary Statistics Median Employee Pay Median CEO Pay Pay Ratio
75th percentile $88,612 $10.5M 172x
Median $58,256 $5.6M 87x
25th percentile $43,966 $2.5M 36x

As expected, the pay ratio correlates with company size, with larger companies disclosing higher ratios. CEO pay varies greatly depending on the size and complexity of the organization. Employee pay has less variability since it reflects the job function and does not vary significantly based on the size of the organization. The median ratio in our sample of 150 companies ranges from 20x for companies with revenue less than $500M to 218x for companies with revenue greater than $15B.

20x 54x 84x 157x 183x 218x <$500M $500M-$1B $1B-$5B $5B-$10B $10B-$15B >$15B Median Pay Ratio by Revenue Size

Few companies, 15, disclose a supplemental pay ratio with only a handful of companies (three) disclosing more than one additional ratio. These companies with supplemental ratios are typically adjusting the CEO’s pay which may exclude anomalies such as a one-time special bonus or equity award. Interestingly, three companies disclosed a higher supplemental pay ratio likely to provide context for a large year over year increase in the 2019 proxy statement.

Location of Disclosure

Nearly 70% of companies disclose the pay ratio after the Potential Payments upon Termination or Change in Control section of the proxy statement. Approximately 25% of companies disclose the pay ratio just before or after the Summary Compensation Table and a small minority, 5%, disclose it in the Compensation Discussion and Analysis (CD&A).

Pay ratio is typically not disclosed in the CD&A, signaling to shareholders that the pay ratio is not used to determine CEO pay levels. Additionally, around 25% of companies include language in the disclosure that the ratio should not be used to compare pay levels to other companies within the industry, region of the country or revenue size.

Measurement Date

The SEC’s final rules give companies the flexibility to use any date within the last quarter of the fiscal year to identify the median employee. Companies most commonly used the last day of the fiscal year or a date within the last month of Q4. It is also common for companies to use a day within the first month of Q4 to identify the median employee.

Measurement Month Prevalence Measurement Date Prevalence
First Month of Q4 29% Last day of Q4 44%
Second Month of Q4 8% First day of Q4 17%
Third Month of Q4 57% Other 33%
Not Disclosed 6% Not Disclosed 6%

Exclusions from Median Employee Determination

Approximately one-third of companies excluded a portion of their workforce when determining the median employee. The most common rationale is the de minimis exemption (approximately 55%) whereby a company can exclude up to 5% of its non-U.S. employee workforce. Companies also commonly cited an acquisition or corporate not responsible for setting pay (e.g., independent contractors) as rationales for excluding certain employee groups.

Conclusion

As more companies continue to file their proxy statements in the coming weeks, we will likely see larger pay ratios, particularly as companies with a significant part-time workforce begin to disclose their ratios. We do not anticipate an increasing trend in the number of companies filing supplemental pay ratios though it will be interesting to see the rationale for those that do. We expect to continue to see companies placing the pay ratio outside of the CD&A with most disclosing it after the Potential Payments upon Termination or Change in Control section.

On a panel of leading executive compensation experts, Margaret Engel discusses some of the top executive compensation issues and trends including: the current public mistrust of executive compensation programs, the importance and the rigorous process of target goal setting, the challenges that many companies face with long-term performance awards, and the likely increase in the use of performance-based stock options in the future.

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