RiskMetrics Group, formerly known as Institutional Shareholder Services (“RiskMetrics”), has published a 2009 update to its corporate governance policies, including new policies on various executive compensation matters.1 Shareholder and political scrutiny of executive compensation pay practices can be expected to continue to intensify in 2009. RiskMetrics has updated its policies in light of the economic and political climate, including the restrictions imposed on executive compensation by companies that receive funds from the federal government under the Troubled Assets Relief Program.
Public companies should be mindful of RiskMetrics’ policies, as many institutional shareholders rely on, or take into account, RiskMetrics’ advice when making voting decisions. In certain cases, the failure to comply with RiskMetrics’ executive compensation guidelines can result in RiskMetrics recommending that shareholders either withhold their vote from, or vote against, a company’s director nominees. Indeed, some of the types of changes to employee compensation plans, including option repricings, that companies may consider in the current environment of declining stock prices and company performance may trigger adverse recommendations from RiskMetrics. These recommendations can take on heightened significance at companies that are seeking shareholder approval of stock or other compensation plans or have implemented majority voting policies for election of directors or where activist investors may seek board representation.
Pay for Performance Policy; Compensation Peer Groups
As has been the case under the prior policy guidance, RiskMetrics will generally recommend against the adoption of, or amendments to, stock or other compensation plans and/or to withhold votes from compensation committee members if:
- There is a pay for performance “disconnect” between a CEO’s total compensation and the company’s stock performance;
- Over half the pay increase to the CEO is equity-based; and
- The CEO is a participant of the equity proposal.
RiskMetrics has updated this policy to utilize a relative approach in measuring a company’s stock performance and will generally now find a disconnect between CEO compensation and stock performance if there is an increase in CEO total compensation and the company’s one-year and threeyear total shareholder returns are in the bottom half of its industry group based upon four-digit Global Industry Classification Groups. Total compensation includes base salary, bonus, non-equity incentives, grant date full value of stock awards and options, target value of performance shares/units, change in pension value, nonqualified deferred compensation earnings and all other compensation. RiskMetrics will then review the Compensation Discussion and Analysis (CD&A) disclosure in the company’s proxy statement to supplement their analysis with particular focus on whether there is a meaningful explanation of the rationale for increased compensation despite “poor” stock performance. Accordingly, companies may want to consider utilizing the CD&A to defend certain compensation practices that might otherwise trouble RiskMetrics.
RiskMetrics revised its methodology for constructing peer groups for purposes of its proxy research reports, which display the pay of Russell 3000 CEOs relative to their peers. Specifically:
- RiskMetrics will focus predominantly on company size – with size parameters ranging from 0.5 to 2.0 times the company’s size, with size generally measured by revenue (although it will look at assets for financial services companies and may also look at market capitalization);
- RiskMetrics will require that the peer group consist of a minimum of 8 companies (rather than 12); and
- In the case of extremely large companies, RiskMetrics may look to wider industry sectors or a market index to create a peer group of companies it believes are similarly situated to the company.
RiskMetrics’ future proxy research reports will include a comparison of the peer group determined by RiskMetrics based on the foregoing criteria with the peer group described in the company’s proxy statement.
Poor Pay Practices; Resetting and Repricing
RiskMetrics has added new examples of “poor pay practices” to its list of pay practices that may trigger a recommendation to vote against or to withhold votes from compensation committee members, the CEO or, potentially, the entire board of directors or against the approval of equity plans or changes to equity plans that incorporate those practices. In addition to RiskMetrics’ prior focus on items such as multi-year guarantees, excessive perquisites, inclusion of additional factors in pension and SERP calculations, internal pay disparity, options backdating and severance or change-in-control provisions with singletriggers or greater than three times salary and bonus payments, RiskMetrics’ new guidelines identify the following additional “poor pay practices”:
- New or materially amended severance or change-in-control arrangements that include provisions for the payment of full or modified excise tax gross-ups or which allow an executive to receive change-in-control severance payments upon a voluntary resignation during a window period following a change in control (single-trigger “walk away” rights). Employment agreements that automatically renew or that are amended to comply with new regulations, such as Section 409A of the Tax Code (Deferred Compensation), are not considered to be materially amended for this purpose.
- Broadly drafted change in control definitions in individual contracts or equity plans which could result in an executive receiving payments without an actual change in control occurring. In addition, RiskMetrics will recommend voting against approval of any equity-based compensation plan with a definition of change in control that could potentially result in payments or acceleration of vesting of awards if a change in control never occurs. Thus, companies should consider amending any change in control definitions which are triggered upon a shareholder vote, rather than upon the consummation of a transaction.
- Providing tax gross-ups on executive perquisites.
- Paying dividends (or dividend equivalents) on unearned performance awards.
Although not specifically identified as a “poor pay practice,” RiskMetrics has stated that it does not view market deterioration, in and of itself, as an acceptable justification for repricing stock options or resetting performance goals and that it views resetting performance goals and repricing stock options as weakening the connection between executive pay and performance.
While we recommend that compensation committees be mindful of RiskMetrics’ compensation guidelines, setting executive compensation is not subject to a one-size-fits-all approach and companies may have valid reasons for implementing compensation programs that do not either fit squarely within RiskMetrics’ “best pay practices” or that facially fall within a broadly described “poor pay practice.” In that event, it should be helpful for the CD&A disclosure to include an explanation of why a particular provision or program was approved. Clear explanatory disclosure may reduce the likelihood of a negative RiskMetrics recommendation and may also serve to cut off or blunt criticisms by activist investors who seek to use compensation and corporate governance as wedge issues in campaigns to obtain board representation.
Previously, RiskMetrics did not support shareholder proposals on “clawbacks” of incentive pay if a company had already instituted its own policy. However, RiskMetrics may now support such proposals if the company’s policy does not meet “best practices,” as defined by RiskMetrics.
In addition, RiskMetrics will evaluate proposals seeking to impose holding requirements (which require executives to maintain a material personal financial stake in their company) on executives who receive stock-based incentives in light of events that call into question the risk-incentivizing behavior associated with certain incentives.
Both of these policy positions, as well as RiskMetrics’ “best practices” for clawbacks, are modeled on the executive compensation restrictions of the Capital Purchase Program, which was implemented as part of the federal government’s Troubled Assets Relief Program.