ISS Proxy Advisory Services recently recommended that shareholders of a small cap bank holding company, Provident Financial Holdings, Inc., withhold their votes from the three director candidates standing for reelection to the company’s staggered board (all of whom serve on its nominating and governance committee) because the board adopted a bylaw designed to discourage special dissident compensation schemes. These special compensation arrangements featured prominently in a number of recent high profile proxy contests and have been roundly criticized by leading commentators. Columbia Law Professor John C. Coffee, Jr. succinctly noted “third-party bonuses create the wrong incentives, fragment the board and imply a shift toward both the short-term and higher risk.” In our memorandum on the topic, we catalogued the dangers posed by such schemes to the integrity of the boardroom and board decision-making processes. We also noted that companies could proactively address these risks by adopting a bylaw that would disqualify director candidates who are party to any such extraordinary arrangements.
Posts Tagged ‘Director compensation’
In our paper, Determinants and Trading Performance of Equity Deferral Choices by Corporate Outside Directors, which was recently made publicly available on SSRN, we investigate the determinants and trading performance of outside directors’ “equity deferrals,” which represent the choice to convert part or all of the current cash compensation into deferred company stock. Director equity deferrals are interesting for two reasons. First, by deferring, the directors give up a sure amount of cash today for firm stock with an uncertain future value, while at the same time substantially increasing the proportion of their compensation that is tied to future firm performance. Second, the equity deferrals can become a form of insider trading, because directors can use these options as a tax-advantaged alternative to open-market purchases of the firm’s stock.
We examine director equity deferrals using a hand-collected sample of U.S. firms that allowed outside board members to defer their cash compensation into equity between 1999 and 2003. We first focus on the factors affecting director equity deferral choices. Consistent with a certainty equivalent story, we find that directors are more likely to defer cash into equity when they receive higher cash compensation levels and when the plans offer premiums for deferrals made into equity. Deferral likelihood also increases with the size of the taxes that are deferred.
Golden leashes – compensation arrangements between activists and their nominees to target boards – have emerged as the latest advance (or atrocity, depending on your point of view) in the long running battle between activists and defenders of the long-term investor faith. Just exactly what are we worried about?
With average holding periods for U.S. equity investors having shriveled from five years in the 1980s to nine months or less today, the defenders of “long-termism” would seem to have lost the war, though perhaps not the argument. After all, if the average shareholder is only sticking around for nine months, and if directors owe their duties to their shareholders (average or otherwise), then at best a director on average will have nine months to maximize the value of those shares. Starting now. Or maybe starting nine months ago.
But this assumes that the directors of any particular company have a real idea of just how long their particular set of “average” shareholders will stick around, and it also assumes that the directors owe duties primarily to their average shareholders, and not to their Warren Buffett investors (on one hand) or their high speed traders (on the other). So, in the absence of any real information about how long any then-current set of shareholders will invest for on average, and in the absence of any rational analytical framework to decide which subset(s) of shareholders they should be acting for, what is a director to do?
Here is what I think directors do, in one form or fashion or another:
Almost half a decade after the onset of the financial crisis, populist sentiment and the resulting political environment continue to fuel stricter regulation of executive and director compensation, with the latest wave in Europe including substantive restrictions on compensation in the financial services industry and “say-on-pay” initiatives (i.e., initiatives providing for shareholder approval of compensation). This post describes these recent European compensation developments, namely:
- The so-called “banker bonus cap” – substantive limits on the amount of variable compensation that can be paid to certain employees at financial institutions; and
- Say-on-pay developments in the E.U. and Switzerland.
This year, the practice of activist hedge funds engaged in proxy contests offering special compensation schemes to their dissident director nominees has increased and become even more egregious. While the terms of these schemes vary, the general thrust is that, if elected, the dissident directors would receive large payments, in some cases in the millions of dollars, if the activist’s desired goals are met within the specified near-term deadlines.
These special compensation arrangements pose a number of threats, including:
The Conference Board, NASDAQ OMX and NYSE Euronext jointly released the 2013 edition of Director Compensation and Board Practices, a benchmarking study with more than 150 corporate governance data points searchable by company size (measurable by revenue and asset value) and 20 industrial sectors.
The report is based on a survey of public companies registered with the U.S. Securities and Exchange Commission. The Harvard Law School Forum on Corporate Governance and Financial Regulation, Stanford University’s Rock Center for Corporate Governance, the National Investor Relations Institute (NIRI), the Shareholder Forum and Compliance Week also endorsed the survey by distributing it to their members and readers.
The following are the major findings from the 2013 edition of the study:
Current views regarding the proper pay plan design to achieve pay for performance vary. This post discusses the three dimensions of pay for performance, demonstrates how to measure them using historical pay data, and presents a simple pay plan that achieves perfect pay for performance (PP4P) using annual grants of performance shares. It also highlights pay practices that weaken pay for performance and offers recommendations for directors to deepen their understanding of pay-for-performance issues.
A recent opinion of the Delaware Chancery Court, Seinfeld v. Slager,  addresses the legal standard applicable to directors’ decisions about their own pay under Delaware law, an important topic as to which there is little prior law. In an opinion by Vice Chancellor Glasscock, the Court held that a derivative claim alleging that directors breached their fiduciary duties by granting themselves excessive compensation survived a motion to dismiss.  In so concluding, the Court also found that the directors’ action did not have the protection of the business judgment rule and was instead subject to “entire fairness” review.
The Court’s decision to require “entire fairness” review means that the claim of excessive compensation could proceed to a full evidentiary trial on the merits. Under Delaware law, a court will not second-guess business judgments of directors if the directors acted in good faith, exercised due care and were not conflicted in the matter. When the business judgment rule does not apply, the judgments may be subject to heightened scrutiny under the entire fairness standard. To meet this standard, the directors must demonstrate that both the process undertaken by directors and the amount of their compensation are fair to the company.