IPO Companies Increasingly Using "Evergreen Provisions" to Bypass Public Shareholder Approval

A new survey published by Presidio Pay Advisors reveals an interesting and telling trend - a dramatic increase in the use of "evergreen provisions" to replenish stock option pools without need for public shareholder approval.

In its 2008 IPO Executive Compensation Survey, Presidio reports that the use of "evergreen plans" among IPO companies has increased nearly 20% each year for the past three years, a notable development in the midst of all the current hoopla around executive compensation (in general) and the say on pay movement  (in particular). 

More background on what it means to be "evergreen" from Presidio:

An “evergreen plan,” or a stock option plan with an “evergreen provision,” automatically gives boards of directors each year a renewable pool of stock shares to distribute to the company’s executives and employees as compensation. The term “evergreen” refers to the fact that the board needs to obtain authorization to institute the plan only once instead of every few years. ... Having an automatically renewable stock option plan removes shareholder oversight, and many see such provisions as a symptom of executive compensation excess.

Kyle Holm, a Principal at Presidio Pay Advisors, tells us a little more about what is going on behind the scenes in this trend:

About half the companies that went public in 2007 implemented "evergreen" provisions in their stock option plans prior to their IPO. Since they were still private when they implemented the provision, it only required the approval of their venture capitalists and board members, avoiding the stringent scrutiny from institutional investors and shareholder advocacy groups. On the other hand, when public shareholders buy the IPO stock, they are implicitly signing off on the evergreen plan.

This is a rather big deal, as our friends at Presidio make plain.  It will be interesting to watch how long/far the pre-IPO "evergreen" provisions are able to increase in prevalence, as awareness of their use and implications grows.

Wharton Study Offers a Different Take on Comp Consultants & Conflicts of Interest

In the midst of all the attention (mostly, if not entirely, negative) that executive compensation is getting these days, there is particular scrutiny of the role of compensation consultants.  A recent report from the Congressional Committee on Oversight & Government Reform focused on the presence of a financial conflict of interest for compensation consultants when they provide both executive compensation advice and other services to the same company - an opinion bolstered by the Committee's finding of a correlation between the level of CEO pay and the presence of just such a purported conflict on the consultant's part.

Into the fray jumps a group of Wharton accounting professors (and others) whose research presents us with a different picture of the situation.  Their study, The Role & Effect of Compensation Consultants on CEO Pay, featured in a recent Knowledge@Wharton article, found that while executives do get paid more when compensation consultants are involved, the CEOs are still held to acceptable pay-for-performance standards.  "We are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary," concluded the researchers.

From the article:

To examine the question of whether consultants' conflicts of interest influenced CEO pay, the researchers divided the consulting firms into two broad groups. Those that may provide no services except for compensation consultation were categorized as having no conflict of interest. The consulting firms that may provide other services were characterized as having potential conflicts of interest. The authors use three different ways of dividing the firms into these two categories -- whether the hired consultant's market strategy is not to provide other services, whether firms disclose that the consultant does other work, and whether the firm's auditor provides non-audit services.

"We find no evidence of rent extraction -- [i.e., giving unjustified or unwarranted pay to the CEO] -- in the form of lower pay-performance sensitivity among the clients of these consultants," the researchers write. "Overall, we do not find compelling evidence that the controversy and accusations regarding the use of potentially conflicted compensation consultants are warranted."

Their conclusions differ from those of Waxman's committee, which based its findings not only on information disclosed in proxy statements of Fortune 250 companies, but also on information specifically requested from six top consulting firms. The firms were asked to provide information on what other services they provided to companies they consulted with.

"In 2006, the median CEO salary of the Fortune 250 companies that hired compensation consultants with the largest conflicts of interests was 67% higher than the median CEO salary of the companies that did not use conflicted consultants," the Waxman report concluded. "Over the period between 2002 and 2006, the Fortune 250 companies that hired consultants with the largest conflicts increased CEO pay over twice as fast as the companies that did not use conflicted consultants."

Carter offers two explanations for the differences between the two studies. She says the Congressional committee did not take into consideration a number of variables that her study did. "The study failed to control for economic determinants of pay and therefore its conclusions should be interpreted with caution," she and her colleagues write. For example, bigger and well-performing firms tend to pay their CEOs more. If these types of firms are also the kind of firms that hire consultants to provide other services, the Committee could have been led to their conclusion, not because the conflicts led to higher pay, but because the characteristics of these firms warranted greater pay, Carter states.

Still, she acknowledges that it's possible the House committee is right and her team is wrong. The Congressional committee had the benefit of subpoena power, Carter says, so it had a clean measure of conflicts of interest because consulting firms provided proprietary information on revenues from executive compensation consultant and other services.

While Carter said she has requested, with no success, the data used by the committee, she, Cadman and Hillegeist concede that the imprecise measures they used might have led to their conclusion. According to Cadman, "without [the Committee's] data, we have no way of knowing the true cause of the difference in conclusions."

For the record, I am not currently involved in providing executive compensation consulting to Fortune 500 size companies, nor do I provide any services beyond compensation/performance management - so I don't see myself as having a particular axe to grind here (other than, perhaps, the wish not to see my profession unnecessarily pilloried).  I do, however, think that the reporting on this issue has been pretty one-sided, and so I welcome the chance to share a different perspective from as reputable a place as Wharton.

Unintended Consequences of the SEC's Executive Pay Reporting Rules: Free NACD Webinar

The more detailed disclosure requirements of the SEC's expanded proxy rules were intended to help investors understand how - and on what basis - executives are being compensated.  Yet two proxy seasons under the new rules have revealed that managements' and boards' concerns about public and investor perceptions of executive compensation are driving some major changes in program designs - some of which may be undermining program effectiveness and transparency.

The National Association of Corporate Directors, in partnership with compensation consulting firm Pearl Meyer & Partners is offering a complimentary webcast on Wednesday April 23, 2008 in which they will explore this conundrum and provide guidance on how to reconcile meaningful performance-based practices with the necessity of providing detailed disclosure of sensitive and complex compensation programs.

Webcast topics will include:

• The danger of dumbing down performance metrics
• Semantics issues with terms such as target, maximum, and threshold
• The need to manage negative discretion on payouts
• Overstating competitive harm
• Reconciling high performance expectations with achievable results
• Disclosure of change-in-control and other severance arrangements
• Dealing with boards' discomfort over the need for more disclosure
• Program design alternatives that do not sacrifice good design for good optics

Click here to get more info on and register for the webcast

Executive Compensation Predictions: 2008 & Beyond

In a recently released statement, Mercer HR Consulting outlined what its executive compensation consultants see as the trends most likely to shape how executive compensation programs are designed and pay decisions are made in 2008 and beyond:

Pay for performance gets the spotlight. All of the factors shaping this proxy season are converging in one important arena – paying for performance. Shareholders want it, the SEC wants companies to disclose specific measures and targets, and companies are looking closely at how performance could be affected by an unpredictable economic environment. We expect to see ”disconnects“ – where awards based on 2007 performance are reported in 2008, a time of depressed share prices and perhaps poor Q1 earnings and revenue reports. Companies will have a difficult time getting their pay for performance story heard.

Goal setting and performance measures revisited in an economic downturn. Uneasy with the volatility of the market, companies are taking a hard look at the drivers of real long-term economic value, reassessing their performance metrics and realigning their variable compensation with financial, strategic and operational measures, as opposed to more traditionally used metrics such as “earnings”. But with so much uncertainty created by the financial market crisis, companies are struggling – more so than ever – with setting credible goals. While some companies can use a relative approach (tied to the performance of an external index or industry group), they need to be prepared to pay, and possibly pay well, for negative absolute performance.

Continued changes in long-term incentive strategy. Surprisingly, the pace of change in the long-term incentive arena doesn’t seem to have slowed. The experimentation with a mix of equity vehicles continues as companies add vehicles or change the allocation among options, restricted stock, performance-based equity and even cash. Some companies have looked at an uncertain economic future and made the decision to reduce or even eliminate performance-based equity until the economy stabilizes.

Reemergence of stock option repricing. Changes in stock price put stress on equity compensation programs, particularly those relying on options. Some companies are examining whether there is a compelling rationale for repricing stock options for all holders, not just executives. The new twist on this old strategy is that now it requires shareholder approval. It remains to be seen whether shareholders will acquiesce at a time when their returns are down.

Market fragmentation: A shift away from “typical” practice. As companies focus on implementing compensation programs tailored to their individual strategies, culture and priorities, we no longer see a “typical” compensation structure employed by the majority of companies – even within an industry group. Even the tech sector, where options were once the only equity vehicle used, now displays a wide array of approaches, using cash and a variety of equity vehicles. Larger companies were the first to break from this norm, but smaller and mid-size companies are quickly following suit.

Shareholder optics has an impact. In light of increased disclosure requirements for greater transparency and specificity, companies are re-examining their total executive rewards. The result: Compensation targeted to the 50th rather than the 75th percentile, more rigor around establishing peer groups for comparing market practices, increased use of clawback, anti-hedging and other policies intended to protect shareholders, and decreased use of perquisites and benefits. Further, the increased pace of executive turnover has had the unintended consequence of affording boards the opportunity to revisit and reshape the terms of employment, including change of control and severance arrangements.

Executive Compensation & the Subprime Mortgage Mess: Gas on the Fire?

Is there a relationship between executive pay and the risky financial instruments linked to subprime mortgages?  Nell Minow, corporate governance expert and editor-in-chief of The Corporate Library makes the case that there is during an interview featured in the February 19 issue of Strategy+Business.

In an excerpt from that interview:

S+B: In what ways were the boards responsible for the current debacle in the financial-services sector?

MINOW: There were a couple of precipitating factors. One is that the boards weren’t paying enough attention. They weren’t asking the right questions. And the other is that they were creating executive compensation plans that had the effect of pouring gas on the fire. You can see how it worked by looking at it in hindsight. All of the CEOs who failed got paid very well. Therefore, the pay plans had very perverse incentives. Yes, the CEOs did receive incentive compensation, but incentive to do what? If the incentive was to essentially offload risks — which is what happened, because the CEOs were pushing much of the risk off to shareholders — then this is what you get.

And further in, when the question was posed about what boards could have done to prevent executive compensation from contributing to the crisis, Minow quotes Warren Buffett:

S+B: What could the boards of financial-services firms have done to help avoid situations like the subprime meltdown?

MINOW: You can’t do better than what Warren Buffett said to the people at Salomon Brothers many years ago: “If you lose money for us, we will be forgiving. If you lose reputation for us, we will be ruthless.” You make the situation clear by stating your intentions and you back them up in the design of your compensation program. If there’s any suggestion of bad behavior, the money goes back to the company. That’s the only fair and credible way. Any CEO who won’t come in on that basis is somebody you don’t want to bet on because he is not willing to bet on himself. The moral of the story is that you get what you pay for. If you tell the CEO he’s going to get paid tremendously for short-term gains even if he has an “après moi, le deluge” philosophy, then he’s going to go for it.

While expressing dismay about the stated aspects of executive pay that she believes contributed to the subprime mortgage mess, Minow also acknowledged - in closing - that there have been tremendous improvements in U.S. corporate governance (exceptions in the financial services sector notwithstanding) and that she is particularly enthusiastic about a number of forces for positive change that are converging on the corporate governance scene:

MINOW: ...three different forces for positive change are coming together at the same time. One is majority voting. I think that’s going to be very powerful as it gets widespread adoption. Right now, under the law, a director who is unopposed can get elected with one vote because voters have only two options: to affirm a candidate or not to vote at all. Thus, it’s not very meaningful to withhold a vote. But as companies adopt the rule that a director must receive a majority of the votes cast in order to win, directors will know they can be voted out if there are a lot of abstentions. Second, the broker vote change will eventually go through so that actual shareholders, or beneficial holders, will vote for directors. (Currently, in many cases, large brokerages hold shares for individual investors and vote on their behalf without consulting with their clients; frequently, they join management in supporting their board slate and opposing shareholder resolutions.) Third, mutual funds and money managers now must disclose which way they voted on board appointments and resolutions under a ruling by the Securities and Exchange Commission.

We do a “naughty and nice” list every year of who votes for shareholder value and who does not. So that will put pressure on mutual funds to vote more thoughtfully. One way or another, votes are going to become much more meaningful. If compensation committees start getting voted out for signing off on outrageous pay packages, then I think boards will start to do a better job.

Executive Equity Awards Increasingly Tied to Performance

An increasing trend toward tying equity awards to performance appears to be underway, according to new research from Equilar, Inc.

Among the findings from its recent study on Q4 CEO equity awards at Fortune 500 companies, Equilar reports that the percent of shares (including outright stock grants as well as options) awarded with performance-based vesting criteria has nearly doubled over the past year, increasing from 8.2% of all shares awarded in Q4 2006 to 14.7% of all shares awarded in Q4 2007.

New Internet Executive Pay Comparison Tool Unveiled by SEC

The Securities and Exchange Commission (SEC) has launched a new online tool that enables instant comparisons of what 500 of the largest public U.S. companies are paying their top executives. 

By tagging the executive compensation figures in SBRL, the computer language of interactive data, the SEC has created a new online tool to help investors more efficiently view Summary Compensation Tables and certain other data in the proxy statements of large companies.  Investors can quickly glimpse the total annual pay as well as dollar amounts for salary, bonus, stock, options and company perks.  They can instantly compare those executive compensation figures with other companies by sorting according to industry or size.

While the tool appears to be designed with investors in mind, it also holds promise for those charged with analyzing and developing executive compensation programs and policies - especially to the extent that the SEC expands the database beyond this initial set of 500 very large organizations.  Here's hoping.

Free NACD Webcast: Tough Questions that Compensation Committees Must Ask

Today Board Compensation Committee members are expected to have sufficient knowledge of executive pay to make sound and informed decisions, yet many Directors hesitate to pose the kind of penetrating questions that dig beneath the surface of an executive compensation program and challenge underlying assumptions.

In response to this need, the National Association of Corporate Directors is hosting a complimentary webcast on Tuesday, November 13, 2007 featuring a panel of experts (Dave Swinford and Jan Koors of Pearl Meyer & Partners, and Kathy Hudson, Lead Independent Director & Compensation Committee Chair of Charming Shoppes, Inc.) who will share their experiences using tough questions to uncover and examine the areas of executive compensation that warrant close scrutiny.  The webcase is scheduled for 11:00 PST, 1:00 CST, 2:00 EST.

A great & free resource for Compensation Committee members as well as the HR and Compensation professionals who support them.  Register here.

Bonuses to Top Nonprofit Executives Rise Significantly

The amount of money that the nation's largest nonprofit organizations paid in bonuses to their top executives more than doubled from 2005 to 2006, according to a recently released Chronicle of Philanthropy survey of executive compensation in 298 charities and foundations.

According to the Chronicle, average bonus payments to top executives grew from $69,477 in 2005 to $142,700 in 2006.

This finding is aligned with what seems to be a growing interest among nonprofit organizations and their boards in tying executive compensation to organizational performance.  To this, I would submit my observation that the nonprofit sector is not yet as experienced as the for-profit sector in developing and managing incentive pay.  The design of incentive plans in nonprofit organizations must reflect considerations not present in the for-profit sector, including - but not limited to - the nature of the organization's tax-exempt mission and the increasing scrutiny of regulatory and other bodies (such as the IRS and Attorneys General) on these compensation arrangements.  One case in point noted by the Chronicle is the Association of Fundraising Professionals which - as part of its professional code of ethics - prohibits members from tying their compensation directly to fundraising performance.  Fundraising executives and professionals, who are also part of the increasing trend toward incentive pay, must develop and use plans that consider and focus on broader, mission-related considerations in order to comply.

Related Posts:

Chronicle of Philanthropy to Hold Online Discussion of Executive Compensation

On Executive Incentives in Nonprofits

Incentive Compensation in Nonprofits

Chronicle of Philanthropy to Hold Online Discussion on Nonprofit Executive Compensation

The Chronicle of Philanthropy will hold on online discussion about executive pay in the nonprofit field on Wednesday, September 26, 12 noon Eastern time.  The discussion, which is open to everyone (not just Chronicle subscribers), will feature as guests Lyn Brennan, an executive recruiter at Battalia Winston International, and Stephanie Geller, a researcher at Center for Civil Society Studies at Johns Hopkins University, and will also cover some "intriguing findings" from the Chronicle's recently released survey of nonprofit executive compensation.

Related Posts:

Bonuses to Top Nonprofit Executives Rise Significantly