Since 2011, all US public companies have been required to submit their compensation plans to a periodic advisory vote by shareholders, which is commonly referred to as “Say on Pay.”  A number of our clients have asked us whether “no” votes on Say on Pay seem to bear any relationship to securities class action (SCA) lawsuits, and whether we are incorporating this information into our litigation model.

The answer to the first question is a resounding “yes.” In both 2011 and 2012, Russell 3000 companies that experienced SCAs were roughly twice as likely as index companies generally to experience Say on Pay “no” votes of 10% or more.  For example, in 2011, nearly 54% of the companies that faced SCAs also received at least 10% “no” votes on Say on Pay; in 2012 over 46% of the companies facing securities litigation had negative votes at this level. These figures are striking because at most companies, “Say on Pay” resolutions are overwhelmingly approved:  across the two years, only 25% of companies in the Russell 3000 experienced “no” votes of 10% or more.

However, it’s important to note that this analysis covers only two years of data (and a total of 130 SCAs), and showed a simple relationship between votes and SCAs that occurred in the same year, without analyzing which came first or how much time elapsed between them.  To incorporate this data into our statistical model, we would need a much larger data set, and would have to track exact dates in order to see if shareholder votes could help predict subsequent SCAs, with various lead times.  So this is a project we’ll likely revisit a few years down the road.

In short, while not conclusive, our review of the first two years of Say on Pay does show a link between shareholder disapproval of pay plans and SCAs.  The reason for this may be that poor compensation practices are associated with other weaknesses in management quality that make firms more likely to face securities class action litigation.

The post Say on Pay “No” Votes Correlate with Securities Class Actions appeared first on GMI Ratings.

On Friday, Daniel Vasella’s chairmanship at Swiss drug maker Novartis ended with the conclusion of the company’s annual general meeting. Vasella’s tenure ended amid a rash of shareholder criticism regarding the now infamous “Vasella Golden Handshake,” which came to light only a week before the AGM. Under the now-cancelled non-compete agreement, Novartis would pay Dr. Vasella 72 million Swiss francs ($77 million) over a period of six years for consulting services to the company while prohibiting him from working for any competitor. During a nationally televised live broadcast, a contrite Dr. Vasella admitted in front of enraged shareholders and the Swiss nation that it was a mistake to have negotiated such a deal in the first place. He also said that he was wrong to have believed that shareholders would give him the benefit of the doubt, since he had announced that most of the money would be used for philanthropic purposes. Heightening the drama is a Swiss referendum to be held on March 3 that, if passed, would give shareholders more power in determining executive pay and would require companies to be more transparent about their pay practices.

While the general public and many shareholders were surprised that such an agreement between Novartis and Dr. Vasella could ever come into existence, GMI Ratings has emphasized for years that executive compensation at Novartis has been and continues to be misaligned with shareholders’ interests. Not only does GMI currently give Novartis a below-average “D” rating for its pay practices, but, as early as 2008, GMI reported that Swiss activist investor group Ethos was pressuring major Swiss corporations, including Novartis, to align executive compensation more closely with shareholders’ interests. At the 2009 AGM, Ethos called on Novartis shareholders to actively support its resolution requesting an advisory vote of the remuneration report. The resolution was defeated at the AGM amid stiff opposition by the Novartis board, but it managed to receive over 31% of ‘yes’ votes. Eventually the company decided to introduce a “say-on-pay” vote at the 2011 AGM after a board-supported resolution calling for say-on-pay was approved at the 2010 AGM.

Even though the adoption of say-on-pay was a move in the right direction, Novartis continued to demonstrate that its executive pay was out of step with shareholders’ interests and expectations. In 2011, GMI flagged Novartis for Remuneration after 38.3% of votes were cast against approval of the company’s compensation system at the 2011 AGM. Opposition to Novartis’ compensation practices was once again headed by Ethos, which stated that not only was executive pay not aligned with shareholders’ interests since “the variable remuneration of executive management is too high compared to the fixed remuneration,” but also that “the various incentive plans are not described in sufficient detail to allow the establishment of a clear link between remuneration received and achievement of pre-defined performance targets.”

In our view, Novartis has had a history of sub-par disclosure and remuneration practices even before the Vasella Golden Handshake outraged an entire nation. It remains to be seen if Novartis can become both more transparent about its pay practices and more responsive to shareholder demands. Unfortunately, the first signs are not encouraging. On Sunday, Swiss publication “Der Sonntag” reported that Novartis was exploring whether or not the company should file criminal charges against the leaker of Novartis’ secret bank account for violating Swiss bank secrecy law. After all, disclosure of the account forced the company to reveal details regarding Dr. Vasella’s non-compete clause. Nevertheless, it is now a certainty that the referendum will indeed pass.

This piece was revised to correct an error related to the date of the referendum.

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In its most recently released proxy statement, Qualcomm Incorporated made it quite obvious to shareholders that the company rewards its executives at the expense of its shareholders.  The company clearly states in the Compensation Discussion and Analysis that its Performance Share Units (PSU) could payout at target despite the shares posting a negative Total Shareholder Return.  Award of Qualcomm’s PSUs are linked solely on company TSR performance relative to the NASDAQ-100.  Because of this, relative underperformance in the form of negative TSR still gives the CEO the potential to earn $8M.  Objectively, a board compensation committee has a duty to establish a fair and justified award structure that is mutually beneficial for both executives and shareholders.  So when a company is willing to pay out over $8 Million worth of PSUs when common shareholders lose value, one has to wonder about the rigor of its compensation oversight.

Rather than evade the issue by burying the pay for fail structure deep in the proxy, Qualcomm is very open with its intentions.  It is hard to miss the fact that executives get rewarded when stock returns are flat to negative.

The company reiterates its perplexing pay philosophy throughout the proxy stating; “The PSU program restricts the amount of PSUs that may be earned to the target amount if Qualcomm’s relative TSR is better than the NASDAQ while our absolute TSR is negative for the 3-year performance period. Thus, no more than the target amount of PSUs may be earned when our relative TSR exceeds the NASDAQ-100 during difficult market conditions.”

While in general, outperforming peers is generally desirable, the fact that the peer group is loosely defined as a broad index, and negative underperformance of a simple benchmark is rewarded with millions, should be a disconcerting realization for shareholders. These practices have been representative of Qualcomm’s ongoing executive pay strategy, which plays a factor in GMI Analyst’s current F ESG Pay rating for the company.

The disregard for an equitable and common sense pay structure reveals that there is a clear disconnect between the Qualcomm boardroom and its shareholders, which has started to manifest itself in the company’s “say on pay” votes over the last two years.  The 2011 annual meeting indicated that shareholders had minimum concern about executive pay with over 94% of voters approving the company’s remuneration policy.  However, the 2012 meeting was the first notable sign of displeasure among shareholders, as the remuneration approval percentage dropped to 68.5%.  Given the 25% year over year drop in approval for Qualcomm compensation practices it will be interesting to see what shareholders have to say in 2013.

The post Qualcomm’s Misdirected Target appeared first on GMI Ratings.

JPMorgan Chase (JPM) released a 132-page report on Jan. 16 that detailed the “London Whale” story surrounding a $2 billion investment fiasco. On the same day the New York financial services firm said its board approved compensating CEO Jamie Dimon $11.5 million for his work in 2012, or around half as much as in the prior year, taking into consideration both the continued strong performance of JPMorgan as well as its recent investment losses, including Mr. Dimon’s responsibility as CEO.

We noted on January 15 that several of the independent directors on JPMorgan’s board have supervised Mr. Dimon for many years. They also earned as much compensation in exchange for their services as some bank employees do. The following is a round-up of media commentary about the board’s recent decision:

“The pay cut was actually a message from the board to regulators and worried investors that it was a strong watchdog over the nation’s largest bank, according to several people with knowledge of the matter.” The New York Times.

“JPMorgan has gone soft on Jamie Dimon over the so-called whale trade. . . The more than $10 million docked from Dimon’s pay will sting, but the board could do more – like removing one of his hats.” Reuters Breakingviews.

JPMorgan said “employees were overwhelmed by the complexity of their bets, risk managers were ill-equipped and leaders including Chief Executive Officer Jamie Dimon weren’t aggressive enough in responding. . . (Michael) Cavanagh, who has worked with or for Dimon since 1993, led the management task force that produced the report. Dimon promoted him from chief financial officer to run the treasury and security services division in June 2010, and again last July to co-head the corporate and investment bank. . .Joe Evangelisti, a spokesman for the bank, said Cavanagh answered to the independent committee of the board, which also conducted its own review.” Bloomberg

“First and foremost, profits rose 53% to $5.7 billion. Revenue was in line with expectations. To no lesser degree: the self-examination stemming from the “London whale” trading debacle seems to be having the desired effect. . .That is: Chief Executive Jamie Dimon appears safe.” Marketwatch

“The problem isn’t that the report is incomplete, lacks analysis or fails to hold people responsible for the mess. . .Given how badly the trade went, it is amazing how right the response by the New York company has been, at least by Wall Street standards.” The Wall Street Journal

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A recent white paper from compensation consultancy Farient Advisors brings a new approach to valuing executive compensation. It premises three main concerns about the existing alternative approaches to  putting a number to compensation – realized pay (the GMI Ratings approach which includes vested stock and exercised stock options) and realizable pay (which attempts to put a value on outstanding equity awards). These are:

• Mismatched time periods for pay and performance.
• Different option valuation methodologies, some of which systematically understate the value of options.
• Using target vs. actual number of shares earned in performance share plans, thereby overstating or understating their value

The authors, Robin Ferracone and Jack Zwingli, discuss a solution to these issues developed by Farient which it calls performance-adjusted compensation (PAC). The key differences between PAC and realizable pay are that PAC gives value to out-of-the-money stock options since they have life left in them and therefore could move into the money, and it only values performance shares once they have vested, rather than trying to ascribe a value to the “target” number shares as realizable pay does.

While I believe this does address some of the flaws of realizable pay, none of the arguments are strong enough to move me away from realized pay because, as the authors admit, “it captures the actual value of the awards received and is not subject to interpretation or manipulation.” The two main arguments against realized pay put forward by the paper only apply if you use it without properly understanding what you are dealing with. Yes, it is nonsense to try and match the profits from a stock option award that has been held for 10 years to a three-year performance period. GMI Ratings does not do that. And, yes, it can create spikes in compensation because executives have power over when stock options are exercised. But this is only an issue when you look solely at a single year’s compensation. GMI Ratings does not do that.

However, the paper serves a very useful purpose in checking the headlong rush towards realizable pay that is occurring at the moment, by calling attention to some of the flaws in that approach and suggesting solutions to them.  These solutions take time, analysis and expertise – never a popular combination because it is expensive – and the only flaw is that they again utilize the Black-Scholes method of option valuation which is, when not in the right hands, as subject to as much manipulation and interpretation as any other pay evaluation… except realized pay.

The post Realized pay realizable pay grant date value pay and now… performance-adjusted compensation appeared first on GMI Ratings.

At the special meeting last week, Xstrata shareholders voted to approve the merger with Glencore but voted against controversial retention payments for managers. So contentious were these merger bonuses that the company removed them from the merger vote so that shareholders could separately approve or disapprove them while allowing the merger to go through. In a press release following the meeting, management not only expressed their regret that the bonuses were not approved, but Xstrata’s chairman – who was in line for the chairmanship of the combined company – indicated that he would step down as a consequence of the rejection vote. Sir John Bond said in a statement:

In the light of shareholders’ decision not to support the board’s recommendation, I have informed the Xstrata plc board and Glencore’s current chairman that, once the Merger has completed, I intend to instruct the board to commence an orderly process to appoint a new independent Chairman of Glencore Xstrata plc.

Sir John is another in a long line (as we have written about earlier this year) of senior British managers to have stepped down over pay controversies and negative pay votes.

Mick Davis, Xstrata’s CEO, also expressed disappointment at the decision, while accepting that shareholders had expressed their opinions.

I regret the decision of shareholders not to approve these retention arrangements for the members of my senior and operational management deemed crucial to the success of the combined group as, in my view, this introduces unnecessary risks to the merged company’s future value proposition

As we had described earlier, initially the retention payments were to be paid one third in cash and one third in Glencore shares, but then on 27 June, in a press release following on from significant shareholder opposition, this was amended to payment fully in shares. The payments were also made subject to performance criteria based on realizing additional cost savings as a result of the merger in the two years following it. All of the documents referencing these changes can be found here. Such moves – always supposing that U.S. shareholders would have objected in the first place – would have been more than enough to have secured support here in North America. It was not enough to gain the support of the minimum 75 percent of shareholders required by the deal in Europe, however.

With Glencore’s shareholders overwhelmingly supporting the deal at their own meeting, all that remains to consummate it is regulatory and antitrust approval from the E.U., China, and South Africa.

Once that is achieved, of course, there is nothing to stop the combined company’s remuneration committee to design a special bonus plan that will incentivize managers to achieve the additional cost savings envisaged in the original arrangements… except the potential for a negative vote on remuneration at the next annual meeting.

Xstrata currently has a remuneration rating of “D” in its home market, with an ESG rating of “F” overall. Its global market ratings, on the other hand, are “C” for both pay and ESG. Glencore, however, is rated “F” in both the home and global markets due to multiple environmental and social violations, including most recently bribery and corruption of an E.U. official, child labor in the Democratic Republic of Congo as well as numerous charges of dumping acid into waterways in the same country.

It is to be hoped that such practices are taken into consideration during the regulatory approval process since this is an opportunity for the authorities to make the approval of the merger contingent on compliance with best practices in all of these areas.

The post Xstrata Shareholders: Yes to the Merger; No to the Merger Bonuses appeared first on GMI Ratings.

Yahoo! CEO Marissa Mayer has poached a Google colleague to be the company’s COO, but not without cost. In a filing yesterday, Henrique de Castro’s golden hello was described.

The package is made up of:

• Base salary and bonus
• One-time retention equity award (vesting over four years)
• Make-whole cash bonus and restricted stock units (vesting over four years)
• Other benefits

Mr. de Castro will receive a salary of $600,000 and, beginning in 2013, he will be eligible for a bonus with a target amount of 90% of salary. The one-time retention equity award is made up of $18,000,000 as restricted stock units and $18,000,000 in the form of performance-based stock options. The restricted stock units will vest monthly over four years. The stock options will vest annually over four years and are subject to undisclosed performance-based vesting requirements. To compensate Mr. de Castro for forfeiture of compensation from his previous employer, he will receive a cash bonus of $1,000,000, and a grant of restricted stock units with a target value of $20,000,000 which will also vest monthly over four years. He will also be eligible for benefits generally available to senior executives at Yahoo! and reimbursement for reasonable legal fees incurred in connection with entering into the agreement, up to a maximum of $25,000. Finally, he will receive a relocation package to help with the move from London to California.

This package adds up to at least $57.6 million, only a fraction of which is based on any kind of performance criteria. It is also almost three times the amount offered to the company’s new CFO, Kenneth Goldman, less than a month ago. Clearly Mr. Goldman was leaving less on the table than Mr. de Castro. Key here, yet again, is the flawed argument behind the payment of so-called make-whole and inducement awards. Executives leaving their current position are doing so because they are being offered a better job. That should be inducement enough. To compensate them for unvested long-term incentives undermines the whole principle of such awards not only at the company the executive is leaving but also at the company he or she is joining. These awards are supposed to reward tenure and performance in the long-term. If an executive leaves, they are doing neither.

Yahoo!’s ESG (environmental, social, governance) rating is currently “C”, with red flags associated with excessive dilution, an issue not helped by the size of the equity awards being handed out to new executives, and a lost Say on Pay vote. More than 50% of shareholders voted against the company’s compensation policies at the 2012 annual meeting. With the regularity of golden hellos being handed out to senior executives, it would seem likely that support for pay at the company will fall even lower in 2013. In addition, the company’s AGR® (accounting and governance risk) rating has been in “Aggressive” or “Very Aggressive” territory since March 2010. While some of this is being driven by excessive officer turnover, other contributing factors are share repurchases, M&A activity, and very high levels of prepaid expenses. The company may be recording erroneous entries in the prepaid expenses account to intentionally overstate sales or understate expenses. This is one of many techniques by which companies can convert operating expenses into assets in order to boost current earnings.

The post Another Golden Hello! from Yahoo! appeared first on GMI Ratings.

The Financial Times first alerted me to an innovative M&A voting process that was introduced on Monday this week by Xstrata to find some way around the current impasse regarding its merger with Glencore. Apart from Glencore raising the price it is going to pay for the company – which must have helped – Xstrata has moved to decouple the controversial retention payments to managers from a vote to approve the deal.

In a press release on Monday, 1 October, a set of new share resolutions were proposed:

1. To approve the New Scheme subject to the resolution to approve the Revised Management Incentive Arrangements to be put to the Further Xstrata General Meeting being passed. The Independent Xstrata Non-Executive Directors intend to recommend unanimously that eligible Xstrata Shareholders vote in favour of only this resolution at the New Court Meeting; and

2. To approve the New Scheme subject to the resolution to approve the Revised Management Incentive Arrangements to be put to the Further Xstrata General Meeting not being passed.

The Revised Management Incentive Arrangements are what the firm calls the retention payments, but what it has done here has been to allow shareholders to vote against the deal, or vote for the deal and the retention packages, or vote for the deal and not the retention packages. The retention packages are up for approval separately. While the deal requires a 75 percent vote for it, the retention packages only require 50 percent to be approved.

The retention packages were first announced in a circular on 31 May 2012. The original proposal was that retention payments equal to two years’ salary, retirement benefits and bonus were to be paid over two years in equal tranches. The amounts for the two eligible executive directors are two times £3,942,785 and £5,451,848 respectively for Messrs Reid and Zaldumbide. Other senior management will receive an aggregate of £16,088,493 and senior employees will receive an aggregate of£ 46,447,660. In addition, Messrs. Reid and Zaldumbide will receive £3,942,785 and £5,451,848 respectively as a buyout of their contractual right to receive a severance payment triggered because they will not be appointed to the board of the new firm

Initially the retention payments were to be paid one third in cash and one third in Glencore shares, but then on 27 June, in a press release following on from significant shareholder opposition, this was amended to payment fully in shares. The payments were also made subject to performance criteria based on realizing additional cost savings as a result of the merger in the two years following it.

These were described in the press release:

The previously announced EBITDA synergy estimate of at least US$500 million per annum includes approximately US$50 million of cost synergies. Vesting of retention awards for Xstrata’s Management will now only occur if additional cost savings are achieved over and above the US$50 million cost savings already identified in the synergy estimate. No additional cost savings have already been identified. Full vesting of the retention award will only occur if a minimum of an additional US$300 million of incremental cost savings arising from the Merger are achieved over the two years post completion.

Such are the differing expectations about compensation governance in the U.S. and the U.K. that forcing a company to capitulate in such a way in the U.S. – introducing criteria for retention payments based on actual cost savings – would have been considered an enormous victory given that the vast majority of such payments in the U.S. vest simply over time. In the U.K., while it has calmed some shareholders who previously opposed the deal, many, such as BlackRock, still adamantly oppose the payments and therefore the deal. With these new voting arrangements in place, the way forward for the deal is opened up.

All of the documents referencing these changes can be found here.

The post Xstrata Bending Over Backwards appeared first on GMI Ratings.

When Marissa Mayer signed the offer letter to new CFO Kenneth Goldman, she penned it “Start practicing your yodel!” Mr. Goldman is likely to oblige, with an aggregate payday in the offer letter that dwarfs recent compensation at Fortinet Inc., a midcap security software company. Before benefits, the target value of his compensation over the next four years at Yahoo! is $17.76 million, compared to $3.4 million in total summary compensation at Fortinet over the prior four years. In his offer letter, the benefits are generalized as “comparable to other executives at your level.”  Yahoo! rarely issues perks, however. Instead, the company grants equity and enough of it so that its dilution rate has averaged 22 percent over the past five years, a key reason why they grade out average in ESG.

Mr. Goldman is set to receive a starting base salary of $600,000; almost twice what he received his last year at Fortinet —which incidentally is also located in Sunnyvale, CA, same as Yahoo. In addition, Mr. Miller will receive a target bonus at $540,000, restricted stock units (RSU’s) ($6 million,) an additional “make-whole” RSU ($1.2 million,) and performance options ($6 million.) To a large extent, the true value of the package will reflect movement in the company stock price. The strike price of the equity is about $16, not much lower than the high end of the company’s $13.11-$16.79 trading range. While the RSU’s are time-vesting, the performance options are subject to performance-vesting requirements yet to be established. Options are expected to be granted on November 26.

Yahoo! did not make the severance of departing CFO Tim Morse known. However, his termination is clearly a management shakeup and not a termination with cause. As such, he should receive nearly $6 million, including about $3.8 million in vested stock, $2.1 million in cash, and continued benefits.

So will Mr. Goldman be paid for performance? He will in a sense. If Yahoo’s stock price drops below the November grant date price for the next several years then his equity would be underwater. In that case, he’d probably make at least $5 million in cash and bonuses and the equity would be worthless. Also, we’ll have to wait to see how challenging the stock option performance metrics appear to be when those are disclosed. Plus, he should get salary increases and higher bonuses than estimated. However, the true reward here is the upside of such enormous equity grants. Equity awards of this magnitude could net windfall profits for even the slightest uptick in the Yahoo! stock price.

The post New Yahoo! CFO has $18 million Reasons to Yodel appeared first on GMI Ratings.

What have shareholders learned from two years of “Say on Pay?”

It obviously will depend on each shareholder but the main lesson is how to manage the enormous logistical nightmare of voting on executive pay for the many portfolio companies they own. This was a sea change in responsibilities at a time when investors were cutting from a department that is not a profit center. Now that the concept of “shareholder engagement” being a year-long process, the proxy season has turned into a year-long event for those investors who take their voting responsibilities seriously. Some still don’t.

What have companies learned?

 That say-on-pay isn’t the end of the world. Even in this era of intense anger over skyrocketing pay, only about 50 companies have failed say-on-pay in each of the first two years. Even for those that failed, the consequences have not been that extreme even though a spate of say-on-pay lawsuits threw a scare into a dozen companies. Given that those lawsuits aren’t failing that well, say-on-pay is well on its way to being a routine along with the rest of the proxy season action items. This was always my biggest beef with say-on-pay – it will cause boards to become complacent because they think they are doing a great job with CEO pay because the voter said so.

Companies have also begun to treat annual meetings like real campaigns. For the first time, they are willing to publicly battle a negative recommendation from the proxy advisors through the use of supplemental letters that rebut what the proxy advisor has said about them. This practice has grown like wildfire with nearly one-third of the companies receiving negative recommendations willing to go to the mat this proxy season.

What is more important in getting a majority “no” vote on pay — the make-up of the pay or the make-up of the shareholder base?

Probably the shareholder base.

How influential are the proxy advisors?

The proxy advisors – ISS and Glass Lewis being the primary ones in the US – are quite influential and have primarily been responsible for boards making changes to pay practices as their policies have pushed the envelope at times. However, their influence has often been overstated – as borne out by several recent studies – and they have been targets for criticism by quite a few corporate interests. 

Surprisingly, at least one of these studies shows that management often benefits from proxy advisor influence – leading me to say “be careful what you wish for” for those managers who bash proxy advisors more out of a knee-jerk reaction to not wanting to make any changes to a broken executive pay process.

What should a company with a “no” vote do?

Schedule a series of compensation committee meetings to develop, approve and monitor an outreach plan to figure out why the vote was negative. Don’t wait for a lawsuit to be spurred into making real changes. And don’t rely solely on advisors – like proxy solicitors – for intelligence about why the vote came in the way it did. Directors should also participate in some of the research to get a firsthand feel of what shareholders are saying about the company’s pay program.

Do shareholders vote “no” on comp committee members when they don’t like the pay?

Sometimes, but less than they used to before say-on-pay became the law of the land. Note what happened at Cablevision Systems recently; the company did not have say-on-pay on its ballot this year because the frequency is triennial (triennial was the choice of shareholders last year) – but then the members of its compensation committee received less than majority support at this year’s annual meeting presumably due to pay issues. The company has a plurality vote standard so there is no direct impact from this vote – but I consider this to be a more serious failure than a nonbinding SOP vote.

Will binding “say on pay’ votes become law in the UK?  In the US?

Yes, seems pretty close to a done deal in the UK. I’ll be shocked if it happens in the US but you never know…

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