#11129 - Executive Compensation - Corporations

Executive Compensation

1. Principles

   1. (1) Compensation plans should properly measure and reward performance

   2. (2) Compensation should be structured to account for the time horizon of risks

   3. (3) Compensation practices should be aligned with sound risk management

   4. (4) Golden parachutes and supplemental retirement packages should align the interests of executives and shareholders

   5. (5) Transparency and accountability should be promoted in the process of setting compensation

2. Forms of Executive Compensation

   1. Salaries and Cash Bonuses: Basic salary and bonuses

   2. Performance Shares: Vesting based upon achievement of performance goals

   3. Restricted Stock: Issued to an employee subject to a restriction that the stock goes bank to the corporation if the employee leaves before a certain period of time

   4. Stock Options: Vesting based upon the passage of time (generally)

   5. Perquisites and Fringe Benefits: E.g. private jets, cars, meals, etc. (disfavored as form of compensation today)

   6. Severance Packages: Large lump-sum payments made upon the removal or resignation of the executive

   7. Supplemental Executive Retirement Plans (SERP): Deferred, periodic compensation of key executives after leaving the firm (generally unsecured and funded entirely by the corporation)

3. Process of Setting Executive Compensation

   1. In public corporations, executive compensation is determined by a compensation committee of the board of directors.

      1. NYSE and NASDAQ listing standards require that the committee be composed solely of three or more "independent" directors as defined in the listing standards

   2. Compensation committees often determine executive compensation through a deliberative process that involves the assistance of professional compensation consultants.

      1. Such consultants use a peer benchmarking process whereby compensation is compared to those offered by other companies in the industry.

      2. This system is intended to ensure that executive compensation decisions are made solely in the best interests of the shareholders in a manner that operates free of influence

   3. The SEC has adopted rules that significantly expands the required disclosures pertaining to a company's use of compensation consultants

      1. Under the current rules, reporting companies must disclose:

         • the role of the compensation consultants in determining or recommending the amount or form of executive or director compensation;

         • the nature, extent and cost of services rendered by compensation consultants or their affiliates for all services (including for services other than compensation advice) when the cost of such services exceeds $120,000; and

         • the measures adopted by the company to address any conflicts of interest on the part of compensation consultants who provide both compensation and non-compensation services to the company

   4. In addition to these SEC rules, the SEC also adopted rules implementing portions of Dodd-Frank

      1. Direct and national exchanges are required to impose specific listing standards requiring that compensation committee members be independent directors

         • In defining independence, the exchanges must consider, among other things, the source of a director's compensation and whether the director is affiliated with the company or its affiliates.

      2. The new rules also permit a compensation committee (rather than the board) to have the sole authority to retain and oversee compensation consultants

         • In selecting an outside compensation consultant, a compensation committee must consider six independence factors:

           • (1) Whether the prospective compensation consultant is providing any other services to the company;

           • (2) What percentage of the consultant's total revenue is derived from its services to the company;

           • (3) Any policies and procedures adopted by the consultant to redress potential conflicts of interest stemming from its services to the company;

           • (4) Whether the consultant has any business or personal relationship with a member of the compensation committee;

           • (5) Whether the consultant owns any stock of the company;

           • (6) Whether any personal relationship exists between the consultant and an executive officer of the issuer.

4. Federal Law

   1. With some exceptions, there are not any federal laws relating to the actual levels of compensation

   2. SEC Disclosure Requirements

      1. Item 402 of Regulation S-K requires the use of numerical tables that permit comparisons over time across companies.

      2. Requires the company's annual proxy statement to disclose the compensation of the CEO, the CFO, and the three highest-paid executives for the current and two preceding fiscal years.

         • Such information as salaries, bonus, stock awards, options grants, incentive plan payments, increases in pension value, and perquisites must be disclosed in tabular form, sometimes with detailed footnotes.

         • In addition, current information about stock-based compensation awarded in the past, such as stock grants and stock options, must be presented in tabular form.

         • The rules also require information on post-employment retirement benefits and deferred compensation, as well as any change-of-control termination fees.

      3. The rules also require broader tabular presentations and improved narratives of how executive pay is set and earned

         • The heart of this disclosure requirement is the Compensation Discussion and Analysis (CD & A)

           • According to Regulation S-K, Item 402(b), the discussion shall describe the following:

             • (i) The objectives of the registrant's compensation programs;

             • (ii) What the compensation program is designed to reward;

             • (iii) Each element of compensation;

             • (iv) Why the registrant chooses to pay each element;

             • (v) How the registrant determines the amount (and, where applicable, the formula) for each element to pay;

             • (vi) How each compensation element and the registrant's decisions regarding that element fit into the registrant's overall compensation objectives and affect decisions regarding other elements; and

             • (vii) Whether and, if so, how the registrant has considered the results of the most recent shareholder advisory vote on executive compensation required by section 14A of the Exchange Act (15 U.S.C. 78n–1) or §240.14a–20 of this chapter in determining compensation policies and decisions and, if so, how that consideration has affected the registrant's executive compensation decisions and policies.

           • In February 2010, the SEC also adopted an extensive set of rules that expand the previously existing compensation disclosures and mandate additional disclosure about the role of a corporation's board of directors in the risk management process

             • The rules require that the CD & A describe how its overall compensation policies do or do not create incentives that might affect its risks and management of those risks but only to the extent that they are "reasonably likely to have a material adverse effect" on the corporation

             • The rule includes a non-inclusive list of specific situations in which disclosure might be required (depending on the corporation and the specific compensation arrangement):

               • The general design philosophy of the compensation policies for employees whose behavior would be most affected by the incentives established by those policies and practices, as such policies and practices policies relate to or affect risk taking by those employees on behalf of the corporation and the manner if their implementation.

               • The corporation's risk assessment or incentive considerations, if any, in structuring its compensation policies and practices or in awarding and paying compensation.

               • How those policies and practices relate to the realization of risks resulting from employees' actions in both the short-term and long-term, such as through policies requiring clawbacks or imposing holding periods of stock.

               • The corporation's policies regarding changes to its compensation policies if the corporation's risk profile changes.

               • Material adjustments to the corporation's compensation policies or practices if the corporation's risk profile changes.

               • The extent to which the corporation monitors its compensation policies to determine whether its risk management objectives are being met...