Institutional Shareholder Services, the influential proxy advisory firm, has published for public comment two proposed changes to its proxy voting guidelines for U.S. companies. The proposals are limited and do not include any change related to the effect of longer board tenure on director independence. ISS had previously surveyed institutional investors and public companies on the topic of director tenure and received strong, but deeply split, responses from both constituencies. The proposed changes are:
Posts Tagged ‘Performance measures’
Editor’s Note: The following post comes to us from Ron Shalev of the Department of Accounting at New York University, Ivy Zhang of the Department of Accounting at the University of Minnesota, and Yong Zhang of the School of Accounting and Finance at Hong Kong Polytechnic University.
In our paper, CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation, forthcoming in the Journal of Accounting Research, we investigate the influence of bonus intensity (i.e., the relative importance of bonus in CEO pay) and alternative accounting performance measures used in bonus plans on the allocation of purchase price post acquisitions. Upon the completion of an acquisition, the acquirer is required to allocate the cost of acquiring the target to its tangible and identifiable intangible assets and liabilities based on their individually estimated fair values. The remainder, namely, the difference between the purchase price and the fair value of net identifiable assets, is recorded as goodwill. The recognition of goodwill has different implications for subsequent earnings than that of other assets. Tangible and identifiable intangible assets with finite lives, such as developed technologies, are depreciated or amortized, depressing earnings on a regular basis. In contrast, goodwill is unamortized and subject to a periodic fair-value-based impairment test. As write-offs of goodwill impairment are infrequent (Ramanna and Watts, 2009), recording more goodwill generally leads to higher post-acquisition earnings.
The confluence of Say on Pay (SOP) votes and heightened scrutiny plus the influence of proxy advisory firms (particularly ISS) are having a major unintended consequence—the movement to “one-size-fits-all” or homogenization of executive compensation programs. It is true that SOP votes have encouraged some valid governance enhancements, for example, significantly more shareholder outreach by many large companies. However, in order to minimize the potential for a negative SOP vote outcome, many companies are changing their pay practices based more on potential external views than business/talent needs. This is particularly apparent in the design of performance share plans with the increasing use of relative TSR (at nearly 50% prevalence). Below we summarize other areas of the executive compensation program that are exhibiting homogenization, the resulting risks and potential steps companies can take to preserve/maximize the linkage to a company’s business strategy and talent needs.
The State Board of Administration (SBA) sponsored an executive compensation research study by Farient Advisors LLC, covering 1,800 companies, 24 Industry groups, and fourteen years of data (from 1998-2011). The research project identifies the primary metrics used in executive compensation plans, overall and by industry, company size, and valuation premiums, and then tests these metrics to determine whether the metrics being used have the highest impact on total stock returns.
The study provides the most definitive answer to date on a critical question—are companies choosing their long-term incentive metrics wisely for the most sustainable benefit to shareowners?
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 growing number of corporations are releasing stand-alone sustainability reports. To provide insight into corporate sustainability performance, many reports contain sets of performance indicators. However, questions remain about what should be reported and the indicators disclosed vary widely. This report presents an analysis of the indicators disclosed in 94 Canadian corporate sustainability reports.
Sustainability policies, plans, programs, and projects have been initiated in corporations around the world. Given the broad nature of sustainability, the breadth and depth of these initiatives varies widely. For example, initiatives as diverse as measuring a corporation’s carbon footprint, fostering diversity in the workplace, and supporting community development could all be classified under the umbrella of sustainability. These initiatives are of interest to a variety of internal and external stakeholders. Depending on the issue, these stakeholders may include employees, investors, customers, suppliers, regulators, nongovernmental organizations, and local communities, to name a few.
One important way corporations share information about their sustainability initiatives is through the release of publicly available reports. Although the titles of these reports differ, they typically include words such as “sustainability,” “responsibility,” “accountability,” or “citizenship,” and they focus on addressing the economic, environmental, and social dimensions of corporate performance through a review of both qualitative and quantitative information. (For the remainder of this issue, the term “sustainability report” is used.)
Most of the empirical work on executive compensation investigates the role of contemporaneous performance measures in setting cash compensation, ignoring the relevance of past performance measures and the structure of cash compensation. In our paper, The Relation between CEO Compensation and Past Performance, forthcoming in The Accounting Review, we focus on the relation between cash compensation components (salary and bonus) and past performance measures as signals of a CEO’s ability.
We first develop a simple two-period principal-agent model with moral hazard and adverse selection. Our model suggests that salary is adjusted to meet the reservation utility and information rent, and is positively correlated over time to reflect ability. Bonus serves to address moral hazard and adverse selection problems by separating agents into contracts with different levels of risk. Agents are screened and receive different bonus arrangements according to their types. The higher an agent’s type, the more sensitive his bonus is to contemporaneous performance. A higher ability agent receives a larger portion of his compensation in the form of bonus and less as salary. For a given agent, salary increases with his past performance and higher current salary predicts higher future performance. Current bonus, however, is negatively correlated with both past and future performance.
As noted by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), “In the aftermath of the financial crisis, executives and their boards realize that ad hoc risk management is no longer tolerable and that current processes may be inadequate in today’s rapidly evolving business world.”  However, especially for nonfinancial companies that may be relatively new to these topics, enhancing risk management can be a somewhat daunting task.
This article focuses on two key aspects of the relationship between risk and strategy: (1) understanding the organization’s strategic risks and the related risk management processes, and (2) understanding how risk is considered and embedded in the organization’s strategy setting and performance measurement processes. These two areas not only deserve the attention of boards, but also fit closely with one of the primary responsibilities of the board — risk oversight.
In 2002, the UK began requiring an advisory shareholder vote on the annual executive and non-executive director compensation practices of UK-incorporated quoted companies (“UK Companies”). Eight years later, in July 2010, the US followed suit when President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), providing for an advisory say-on-pay vote for most large US public companies.
The UK government has now gone one step further by proposing to reform the approval process for director remuneration, including through the introduction of a binding shareholder vote for all UK Companies that must occur not less frequently than every three years. The new UK proposal does not stem from guidelines or mandates adopted by any European or other supra-national body. Rather, the proposal was the initiative of the UK government made at the national level in consultation with companies, shareholders, institutional investors and other interested parties. The UK approach, if ultimately implemented as expected, could be a powerful example for US investors seeking to drive change in executive compensation practices.
We discuss below the current state of say-on-pay in the US and the UK reforms.
In the paper, The Effectiveness of Institutional Investors in Evaluating Analysts, which was recently made publicly available on SSRN, we examine the effectiveness of institutional investors in evaluating analysts by comparing the performance of recommendations made by AAs—star analysts elected by institutional investors—with those made by other analysts.
We ask four related questions. First, does the AA status at least partially reflect analyst skill? That is, if AAs make more valuable recommendations, is it because of skill, or other factors such as luck, market influence, or access to management? If investors are effective in evaluating analysts, we expect the AA status to be indicative of skill. Second and closely related to the first question, does the AA status contain information about the analyst that is not entirely captured by other observable characteristics? The answer should be affirmative if institutional investors uncover unique information about analysts. Third, can institutional investors and the AA election process adapt to major changes brought to the industry by regulations and labor market movements? And finally, who benefits the most from the elected star analysts’ views?