On September 17, 2019, at its fall conference held in Minneapolis, the Counsel of Institutional Investors (CII) announced its revised policy on executive compensation. The Counsel of Institutional Investors (CII) is a nonprofit, nonpartisan association of pension funds, other employee benefit funds, endowments and foundations. The CII iterated that “[e]xecutive compensation should be designed to attract, retain and incentivize executive talent for the purpose of building long-term shareholder value and promoting long-term strategic thinking.”
Readers can draw their own conclusions but some of the recommendations advanced by CII, if implemented by a board or compensation committee (e.g., CII’s stance on employment agreements, acceleration of equity vesting upon a change in control and its cautious approach to the use of peer group benchmarking), will almost certainly be met with resistance from executives being recruited into key corporate leadership positions and their attorneys.
Among CII’s recommendations are the following:
- A board’s compensation committee should be independent, should retain outside experts free of any conflicts of interest, and should commit to executive compensation practices that advance the company’s core objectives and are commensurate with long-term shareholder return.
- The CII recommends that employment contracts should be used only in limited circumstances. This ignores the reality that contracts bring clarity and reduce the likelihood of litigation in the event of a contentious termination of employment.
- According to the CII, fixed pay remains a legitimate component of executive compensation and in many cases, may be considered as a significant element of executive compensation, “particularly where it makes sense to disincentivize ‘bet the company’ risk taking.”
- The CII also commends restricted stock with extended, time-based vesting requirements as a vehicle for providing an appropriate balance of risk and reward to the executive by aligning compensation with shareholder interest.
- “Long-term” in reference to executive compensation should be based on a minimum of a five-year horizon: “Extended vesting periods reduce attention to short-term distractions and outcomes.” (Note that in 2017, 86.0% of Equilar 500 companies utilized a three-year period for their LTIPs, a 17% increase over 2013).
- The CII also encourages boards to be cautious and judicious in their use of performance-based compensation, be it in the form of a cash incentive or performance stock or stock units. Although this form of variable compensation may provide appropriate incentives, CII posits that they require “rigorous oversight and care” in design and in making such awards, because among other things, they are susceptible to manipulation. (Note that recent trends in executive compensation practices favor performance-based awards as a key component of executive compensation.)
- The CII warns that “Executives may use their influence and information advantage to advocate for the selection of metrics and targets that will deliver substantial rewards even without superior performance (e.g., target awards earned for median performance versus peers).” It also worries “overreliance on benchmarking to peer practices” can “escalate executive compensation and lead compensation committees to adopt pay practices that may not be optimal for their companies,” especially when committee members and compensation consultants engage in “opportunistic peer group selection.”
- Although the CII’s cautious approach to the design and administration of performance-based awards is well-taken, an overemphasis on such worries could cause one to overlook the reality that a company’s peer group often is the most appropriate benchmark for measuring performance. For example, if a company outperforms its peer group in a broad or sector-based bear market, that Executive should be rewarded for outperforming that peer group and maximizing the relatively small shareholder gains or mitigating shareholder losses. By the same token, a company should not reward executives with performance-based awards if the Executive does little or nothing to advance the company’s needle compared to its peers.
- The CCI recommends that change in control provisions should be “double-triggered” and companies should not provide automatic accelerated vesting of all unvested equity awards and that the board or compensation committee should retain the discretion to permit full, partial or no accelerated vesting of equity awards not yet awarded, paid or vested, depending on the circumstances. However, a change of control provision which a board or compensation committee retains the absolute discretion to revise or revoke is of little value to a well-oriented executive.
